Yellen,FOMCminutesandtulipmania

There were a few important news items which peppered the economic landscape during the last few hours. First one was a lengthy column which the US Treasury secretary wrote about the importance of rebuilding America and the approach which needs to be taken for that. The 10-minute read is available on the net and presents a nice peep into the thinking of the new administration. The second news was the release of minutes of FOMC last meeting. It provided an insight on what the participants were thinking and how their concerns can feed into future actions on the monetary front. The next news was about the melt down of digital currencies in trade yesterday. Some of the losses were recouped but the game was not for the faint hearted. There were some other news items on the expectation of some sort of cease fire in the ongoing hostilities in the Middle east.

Now as we have written previously that the markets assimilate every incoming information and reconfigure the price which they churn out. A traditional way of thinking would lead us to believe that an equilibrium emerges after every news. For example Yellen’s long speech gives information that the spending pedal by the government is going to be pressed hard with the American Jobs plan and American Families plan over the course of next 10 years with a sizeable investment into infrastructure, environment protection and reduction of inequality. The funding for a proposed plan would come from an increase in corporate taxes. These statements can hardly be described as “pulling a rug off the feet”, they are more long term in nature. But markets understand that more government means more borrowing as a tax increase is easier said than done. Net impact should be equities stable, bond yields up.

The other news on FOMC minutes was slightly more hawkish than market expectations. Committee members were keen to discuss the issue of tapering sooner than later. The impact of such an expectation mismatch should be equities down and Dollar strength. Slight risk off, EM currencies should be down. Now readers should note that the above market reactions work on the premise of ceteris paribus which means all other conditions remaining the same. However global markets hardly ever experience the condition as required by the Latin phrase. The world is changing bit by bit every microsecond. The reaction to Yallen and FOMC hence disappear quickly. The trader who might be trading on a minute by minute timeframe may make a profit if he/she has put the bets correctly.

Now we will come to the last point about the meltdown in the digital currency pack. The charm of this new entrant in the market is built upon the utopian premise of decentralization of money. Money which for millennia has been tightly controlled by the sovereigns will shift its base to a more democratic form. Alas the road to utopia is hardly linear. As with any fad in history the early participants are not the evangelists but the speculators. Only with time any system develops maturity (read liquidity). Economic historian Niall Fergusson writes in his majestic book The Ascent of Money writes about the 20-fold increase in the price of Tulips in Netherlands during a two-year period between 1636 and 1637. The tulip mania subsided quickly as futures lost 99% of its value but the episode made the markets and its practitioners more robust for the future. How the current period will pan out and who will survive to become more robust, sadly only the future can tell.