ECB policy, Vaccine trials and Unintended consequences

Any analysis of the events related to global markets is primarily concerned with two pillars - growth and inflation. Any policy action either on the monetary or fiscal front ultimately gets derived from the interplay of only these two parameters. Growth is anaemic, push the liquidity pedal, cut rates. Higher liquidity is resulting in high inflation, raise rates. But the complexity of real economy can hardly be captured with such a simplistic model as the cause and effects might not be so visible or so immediate. The impact of any policy measure can be hidden in the economy for a long period of time and can manifest somewhere else in a totally different form.

The problem exacerbates when the standard economic beliefs about growth and inflation meet an unexpected entity like a covid pandemic leading to peace time measures being jettisoned. The measures taken for temporary relief can lead to permanent dislocation in the valuation of asset prices (most of which is unintended). Our readers would remember that many a times giving a coherent reasoning about movements in either stocks or bonds becomes difficult. The final refuge obviously is to reduce any movement to the “risk on” or “risk off” dichotomy.

Talking about the unintended consequences let’s take a recent and relevant example from the covid domain only. There are multiple vaccines in different stages of development to counter covid. But similar to monetary and fiscal policies even vaccines are not a one way street. The recent news about a big pharma company facing issues during the human trial stage points in that direction only. The case that a vaccine volunteer developed neurological symptoms is nothing but an undesirable manifestation of unintended consequence.

As for the markets, the US stock markets rebounded after two days of losses. Taking its cue from the US, the Asian markets like the Hang Seng, Nikkei and Nifty are also trading in green. The dollar index has retreated from the high of 93.65 to trade at 93.20 currently. The US 10 year yield is trading at 0.69. Gold is trading around 1945$/oz level and Brent crude is around 40$/bbl.

The major news for the day will be the ECB meeting where the rates are expected to be kept unchanged. As we noted earlier, growth and inflation concerns will be at the helm. The European economy contracted by 12% in the recent quarter and the recent inflation readings have been in the negative zone with the August number coming in at -0.2%. The recent rise in the Euro against the dollar also resulted in Eurozone exports getting costly and negatively impacting the powerhouse economies like Germany. All in all, the market will be keen to watch if there is some addition to the PEPP program.

Domestically, Indian bonds had a good day yesterday where the 10 year benchmark yield moved left by close to 10 bps. In India the all important inflation data is to be released on 12^th September, the expectation is around 6.9% for the month of August. The number, if it materialises, will again breach the RBI target band.