A relaxed read on the issues of the day
The emergence of the omicron covid-19 variant triggered considerable volatility in markets at the end of November, bringing to an end a period of relative calm in equity markets, which had made ground consistently over the preceding month and a half. Investors sought ‘safe haven’ assets such as government bonds, as they moved away from equities. With the situation evolving rapidly, data is somewhat scarce, but early indications suggest that the omicron variant is mild if highly infectious, with existing vaccines offering at least some protection against this new strain.
In the UK, unemployment has remained low following the end of the furlough scheme and consumer confidence has been strong, contributing to economic growth. This contrasts to Europe, where increasing covid case numbers and restrictions / lockdowns combined with higher inflation has dented economic growth and consumer confidence. The successful transition from furlough to alternative employment for many UK workers and the strength of the labour market has opened up the possibility of an interest rate hike from the Bank of England.
Until the emergence of omicron, markets had been fretting about higher inflation and problems in China, but the new covid variant has prompted a re-think from central banks. Whilst its possible that omicron leads to lower levels of economic activity in the short term, which could help to ease inflationary pressure, the Federal Reserve has a different take on the potential consequences for inflation. With the US currently grappling with inflation in labour markets, transport networks and supply chains, the Fed’s view is that the covid has been the cause of inflation and omicron could exacerbate inflationary pressures. Consequently, the tone from the Fed has changed and we may now see a faster end to quantitative easing, with higher interest rates in 2022.
In the event omicron is more dangerous or difficult to deal with than expected, equity markets could experience a further setback, although that doesn’t seem the most likely outcome. Even if existing vaccines prove to be less effective against Omicron, it has been estimated that those vaccines could be updated to offer better protection in the next three to six months. With this in mind, we don’t think equities have the potential to drop as dramatically as they did in early 2020.
The impact of omicron will be felt across markets, but with central banks poised to act, it’s bond markets where we are most alert to the ramifications. In equity markets we have already seen evidence of investors looking to take advantage of lower valuations and ‘buying the dip’. As we head towards 2022 and what is likely to be a bumpier ride for investors, the market focus will likely be on businesses that are in good shape, along with the level of policy support from central banks and governments.