Corona's second wave, US GDP and Mervyn King

As the new week starts the main news which is now in headlines is the rise in number of covid cases in the US and Europe. The US reported close to 80,000 cases on Saturday with 84,000 cases on Friday. The new daily cases numbers are quite in contrast to what we saw in the month of September where the daily number was hovering around 40,000 – 50,000 per day. The number has steadily climbed in the last 7 days to above 80,000 levels. Similarly across Europe the numbers are also rising with France itself registering 52,000 new cases on Sunday. The rest of the Europe is no better with Spain announcing a new set of emergency rules like curfews and a ban on travel. Mainland China on the other hand reported 20 new cases on Sunday.

The second wave across the world is expected to be followed with the familiar script of restrictions and lock down resulting in an economic abyss. The equity markets like the Nikkei and Shanghai Comp trade in red whereas the Hang Seng trades in positive territory. S&P futures have also opened in red as the talks on a second stimulus don’t seem to be heading for a conclusion. We will see the US GDP data for the third quarter on Thursday and the expectations are that it will show that GDP rose by 30% annualized in the third quarter. In the second quarter GDP had contracted by an annualised rate of 31.4%. Here a word of caution that the numbers are annualized. In the US whatever contraction/expansion happened to the economy during the quarter is multiplied by four to arrive at the annualized number.

This week we will see the monetary policy meetings from the central banks of Bank of Canada, Bank of Japan and the ECB. The expectations around meetings is that any action on the rate front is unlikely. The ECB, though, will take note of the second surge in virus cases and will accordingly alter its growth and inflation outlook. The V-shaped recovery will give way to a W or K and possibly be appended with the assuring phrases like “we continue to monitor the situation closely and will keep our fire power ready (aka add to the PEPP program).” Markets will definitely rejoice in the promise of an elongation of the low rate regime and ample liquidity.

Now coming to the point about the “continue to monitor” phrase. The  future is uncertain and not knowable, even with the best access to data. The models which try to capture the current and predict the future are at best imperfect and at worst blatantly wrong. In the book Radical Uncertainty: Decision Making for an Unknowable Future, authors John Kay and Mervyn King (Mervyn King served as the Governor of BOE for 10 years from 2010-13) write at length about this problem. The authors’ central thought in the book is that the real world problems are of two types: one is puzzle and the other is mystery. Puzzles are characterised by a set rules and definite outcomes. With more knowledge you can hope to solve puzzles, but mysteries, on the other hand, are wicked as they don’t come couched in any format. Your best bet with mysteries is just to know “what is going on here rather than what will happen”. The authors’ lament that many economic forecasters, including the ones at mighty central banks, mistake mystery for puzzles. Their models try to solve the puzzle and invariably come short. We will revisit this train of thought in greater detail in future notes.

Domestically, the bond markets are enjoying a good run. After the OMO announcement the Friday auctions saw heavy participation. After the aggressive better than expected cut offs yields fell sharply on shorter duration by 6-10 bps and were down 4-6 bps on the longer tenors. The 10 year benchmark bond closed at 5.85 on Friday. MPC minutes on the last policy discussion were released on Friday with members mostly convinced about room for further easing. As per the WSS released on Friday, India Fx reserves stood at an all-time high of USD 555 bn for the week ending Oct 16.