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If we have to choose two important themes for the discussion today, they will be the decline in the dollar index and the unrelenting rise in equity markets.
The dollar index is trading at 92.30 currently having touched a low of 92.15 in the early trade. This is its lowest level since 2018 and a neat 10% correction from the level of 102 seen in March this year. The relative outperformance of the Euro zone vis-à-vis the US in handling the pandemic has been one of the major reasons. The risk on sentiment has also helped as investors are more confident in pulling out of the safety of the dollar and investing elsewhere.
The second important news is regarding the rise of equities across the board. In the US, the S&P 500 is trading close to its pre pandemic highs. The other index, the Nasdaq, has already surpassed the February highs. If one looks at the Q2 GDP data coming out recently, we see the complete decimation of economic activity but curiously the equity markets, which eventually thrive on that activity, show no signs of that stress. What can be the reason? As per the valuation courses taken long back, we know that current value is primarily the summation of present value of discounted future cash flows. Now there are two components here future flows and the discount rate. Markets are heartily convinced that discount rates are going to be benign deep into the future.
Author James Gleick, in his book Chaos, introduces us to the basic tenet of chaotic systems. He writes that such systems produce vastly different results/outcomes if there is a slight change in the initial conditions. For example, an outcome can change by a factor of two even when the initial input changes by .001%. Readers can now see the link to the equity market argument here. As the potential cash flows go further into future, the present value becomes increasingly dependent on the discount rate assumptions. The bond investors understand this phenomenon intuitively as a high duration trade. A high duration portfolio is expected to gyrate excessively with a small change in interest rates. Hence the present state of equity markets is a bit more chaotic with the primary belief that the easy liquidity and low interest rate regimes will continue for a considerable time to come.
In the other important news the agreement on the second pandemic relief package looks more likely now as some unconfirmed reports indicate that Democrats have agreed to halve the package size to USD 1.5 trillion which brings them closer to the Republican proposal of USD 1 trillion. The package, whenever announced, will be helping the cause of risk on assets. We are sure that markets won’t wait for the actual announcement and would have already assimilated the news.
Domestically, the INR has opened stronger keeping in line with the broad dollar decline. The yields though have moved right with the GS 5.79 2030 having breached the 6% mark. The expectation of rate cuts in the near future is wearing thin and there has been no support in the form of any OMO announcement, which has resulted in a hardening of yields. The GDP data at the end of the month remains crucial. On the other hand flows into the markets have been good as the month to date has witnessed 39k Cr INR inflows.
Markets now await the Fed minutes due to be released today, this will move to reaffirm the accommodating belief. The US election race hots up. The former First Lady yesterday speaking at the DNC said that Americans need to end the Trump “Chaos”. Thankfully our readers now know how we define chaos technically.