Rate hike in Turkey, OMO rejection and puzzling case of gold

The two important US news items yesterday were the slight inching up of the initial jobless claims and the restart of negotiations on the second pandemic relief package. The initial jobless claims rose 4000 to 870k against the expectation of 850k. The number of continuing claims, which is the number of people already collecting the benefits, fell by 167k to 12.58 million.

On the pandemic relief bill, Democratic party leader Nancy Pelosi indicated that the Democrats will draft a new corona virus relief bill and bring it to vote before October 2^nd. The new package will be in the range of USD 2.2 trillion. The two sides from the start of negotiations have been stuck at the quantum of the package, with Republicans touting a size of USD 1 trillion (HEALS Act) and Democrats initially at USD 3.4 trillion (HEROES Act). The Treasury Secretary Steve Mnuchin told the reporters that he has spoken to the speaker Pelosi at least 15 to 20 times in the last few days. The market remains cautious in its optimism of any bill passing. The Dow Jones though closed in green yesterday. The dollar index is trading at 94.30 now.

In other news one surprise was from the stable of the Turkish Central Bank where the bank raised the interest rate by 2 percent to 10.25%. The move is seen as the first salvo to contain inflation and provide support to Turkish Lira. TRY has been trading at a lifetime low of 7.61 currently having witnessed a drop of close to 11% in the month of September. Readers would remember that high interest rates were a point of emotive debate in the last presidential elections when the President Erdogan termed them as “inflationary” in an unorthodox economic logic.

Looking at other GM parameters, the euro is at 1.1667, pound is at 1.2750, JPY at 105.38, offshore yuan as 6.82 and gold is at 1870 $/oz.

Of all the parameters the drop in gold looks a bit puzzling. The common wisdom states that during any times of high risk, apart from a rally in dollar the other natural safe haven is gold which should see a price rise. Gold also gets a fillip when the central banks crank up their printing press. The narrative at work at that time is unconstrained fiat money versus limited supply of gold. The recent gold drop can be attributed to a possible belief that no further stimulus is coming but that is a bit far fetched.

At this point a small detour on the relationship between central banks and gold would be instructive. In modern financial times the currencies are not backed by any precious metal holdings. The gold standard (where currencies were linked to gold) was finally and conclusively booted out in 1971 but still as per a WGC report in 2018 the world central banks (Bank of Canada being a notable exception) and finance ministries across the world own a total of 33000 metric tons of gold. One would do well to ponder on this question - If the fiat currencies are not backed by gold then why do the central banks hold it?

Domestically, the big news of yesterday was the non-acceptance by the RBI of any offers in yesterday’s INR 10k Cr OMO. The central bank subsequently announced a fresh OT for the same size. The rejection indicates that the RBI is not very comfortable in buying at prices much higher than the current levels. The 10 year benchmark bond trades at 6% currently.