USyields,newcasesinChinaandinflationdiscussion

Yesterday the important news was from the domestic counter where the CPI inflation for the month of December came at 4.59%. The November reading was 6.93%. This is important as the inflation reading has come within the RBI comfort band after 7 months. The major contributor to the low inflation reading was the decline in food prices which eased considerably apart from a favourable base effect which kicked in this time. Now the implication of a such a better than market expectations number was visible in the yields as the 10-year benchmark yield softened by 3 bps.

Our readers would recognize that inflation is one topic which we keep discussing at length in our notes. Surely among the various gods in macro-economic pantheon like GDP, debt, employment, interest rates etc inflation occupies a central place. Let us briefly discuss, why this is so.

IMF economists Leslie Lipschitz and Susan Schadler write in their Macroeconomics book that relative prices are the nerve impulses of the market economies and inflation which measures these changes hence becomes a cardinal metric to watch out for. Any increase or decrease in the price of a product signals the producer to alter its production mix, that results in changing the mix of labour and capital away from a certain product to another. As per the author duo, what inflation does is that it garbles up the price signals and ends up creating misallocation of capital. Apart from the redistributive impact of inflation across creditors and debtors (i.e. high inflation reduces the real value of debt), the capital reallocation gives rise to formation of bubbles.

In the global markets round up, the US stock markets ended with slight gains yesterday with the futures also up in the morning trade. The 10-year US treasury yields are trading around 1.11% levels after witnessing a one-year high level of 1.18% in the previous session. The Dollar Index is trading at 90 level which is down from 90.70 seen on Monday. The Fed officials in the coming days are expected to provide their views on the bond purchase and the balance sheet policy in the coming days which will impact the yields. Any such taper indication will be closely linked to the improvements in the economy. The strategy employed by the incoming US administration on a vaccine roll out will also determine how quickly the economy can be reopened.

Meanwhile in China, the country recorded the biggest daily jump in number of covid cases in more than 5 months. The hotspot this time being in places near the capital Beijing. Onshore Chinese Yuan is trading at 6.45 which is close to its 30-month high levels against the USD. One more currency pair which would be interesting to watch out would be the AUD/USD which is inextricably linked to the Chinese economy and has been in past used by the market participants to take a proxy bet on any economic development in mainland china.