There once was a narrative told
Explaining the Fed still controlled
The market’s reaction
Thus, making sure stocks ne’er got sold
But that was before Omicron
Evolved and put more pressure on
The future success
Of Fed’ral largesse
With no real conclusion foregone
So, later this morning we’ll hear,
When Janet and Jay both appear,
In front of the Senate
If they’ve still the tenet
That all will be well by next year
Perhaps all is not right with the world. At least that would be a conclusion easily drawn based on market activity this morning. Once again, risk is being shed rapidly and across the board. Not only that, but the market is completely rethinking the idea of tighter monetary policy by the Fed with the growing conclusion that it is just not going to happen, at least not on the timeline that had been assumed a few short days ago.
It seems that the Omicron variant of Covid is proving to be a bigger deal in investor’s eyes than had been originally assumed. When this variant was first identified by South African scientists, the initial belief was it was more virulent but not as acute as the Delta variant. So, while it was spreading quite rapidly, those who were infected displayed milder symptoms than previous variants. (If you think about the biology of this, that makes perfect sense. After all, every organism’s biologic goal is to continue to reproduce as much as possible. If a virus is so severe that its host dies, then it cannot reproduce very effectively. Thus, a more virulent, less severe strain is far more likely to remain in the world than a less virulent, more deadly strain, which by killing its hosts will die off as well.)
In the meantime, financial markets have been trying to determine just what type of impact this new strain is going to have on economies and whether it will induce another series of lockdowns slowing economic activity, or if it will be handled in a different manner. And so far, there is no clear conclusion as evidenced by the fact that we saw a massive sell-off in risk assets Friday, a major rebound yesterday and another sell-off this morning. If pressed, I would expect lockdowns to come back into vogue as despite questions over their overall efficacy, their imposition allows government officials to highlight they are ‘doing something’ to prevent the spread. Additional bad news came from the CEO of Moderna, one of the vaccine manufacturers, when he indicated that the nature of this variant would likely evade the vaccines’ defense.
So, story number one today is Omicron and how this new Covid variant is going to impact the global economy. Ironically, central bankers around the world must be secretly thrilled by this situation as the focus there takes the spotlight off their problem, rapidly rising inflation.
For instance, after yesterday’s higher than expected CPI prints in Spain and Germany, one cannot be surprised that the Eurozone’s CPI printed this morning at 4.9%, the highest level since the Eurozone was born in 1997, and far higher than any of the 40 economist forecasts published. Madame Lagarde wasted no time explaining that this was all temporary and that by the middle of next year inflation would be back to its pre-pandemic levels, but it seems fewer and fewer people are willing to believe that story. Do not mistake the run to the relative safety of sovereign bonds as a vote of confidence in the central bank community. Rather that is simply seen as a less risky place to park funds than the equity market, which by virtually every measure, remains significantly overvalued.
This leads to the third major story of the day, the upcoming testimony by Chairman Powell and Treasury Secretary Yellen in front of the Senate Banking Committee. The pre-released opening comments focus on Omicron and how it can be a risk for both growth and inflation thus once again trying to divert attention from Fed policies as a problem by blaming exogenous events beyond their control. Of course, this story will resolve itself starting at 10:00, so we will all listen in then.
Ok, with all that as prelude, a quick tour of markets shows just how much risk is in disfavor this morning. Overnight in Asia we saw broad weakness (Nikkei -1.6%, Hang Seng -1.6%) although once again Shanghai was flat. Europe is completely in the red (DAX -1.45%, CAC -1.25%, FTSE 100 -1.0%) and US futures are also pointing lower (DOW -1.2%, SPX -1.0%, NASDAQ -0.5%).
Meanwhile, bond markets are ripping higher with Treasuries (-5.1bps) leading the way as yields fall back to levels last seen in early September. In Europe, Bunds (-2.1bps), OATs (-2.2bps) and Gilts (-4.0bps) are all seeing demand pick up with the rest of the Continent all looking at lower yields despite rising inflation. Fear is clearly a powerful motivator. Even in Asia we saw JGB’s (-1.9bps) rally as did Australian and New Zealand paper.
Commodity markets are having quite a day with some really mixed outcomes. Oil (-2.5%) is back in the red after yesterday’s early morning rebound faded during the day, and although oil did close higher, it was well of the early highs. NatGas (-5.0%) is falling sharply, which at this time of year is typically weather related. On the other hand, gold (+0.5%) is bouncing from yesterday and industrial metals (Cu +1.4%, Al +1.6%, Sn +2.7%) are in clear demand. It seems odd that on a risk-off day, these metals would rally, but there you have it.
Finally, the dollar can only be described as mixed this morning, with commodity currencies under pressure (NOK -0.4%, CAD -0.25%) while financial currencies (EUR +0.5%, CHF +0.5%, JPY +0
4%) are benefitting on receding expectations for a tighter Fed. PS, I’m sure the risk off scenario is not hurting the yen or Swiss franc either.
Emerging market currencies are demonstrating a broader based strength with TRY (-1.6%) really the only major loser as further turmoil engulfs the central bank there and expectations for lower interest rates and higher inflation drive locals to get rid of as much lira as possible. Otherwise, PLN (+0.8%) is leading the way higher as expectations for the central bank to raise rates grow with talk now the rate hike will be greater than 50 basis points. But MYR (+0.8%) and CZK (+0.75%) are also showing strength with the ringgit simply rebounding after a 10-day down move as bargain hunters stepped in, while the koruna has benefitted from hawkish comments from the central bank governor. It appears that most EMG central banks are taking the inflation situation quite seriously and I would look for further rate hikes throughout the space.
Aside from the Powell/Yellen testimony, this morning brings Case Shiller House Prices (exp 19.3%), Chicago PMI (67.0) and Consumer Confidence (111.0). As well, two other Fed speakers, Williams and Clarida, will be on the tape, but it is hard to believe they will get much notice with Powell front and center.
The dollar appears to be back following the interest rate story, which means that if expectations of Fed tightening dissipate, the dollar will likely fade as well, at least versus the financial currencies. Commodities have a life of their own and will continue to dominate those currencies beholden to them. The tension between potential slower growth and rising inflation has not been solved, and while my view is the Fed will allow inflation to burn still hotter, keep in mind that if they do act to tighten policy, the dollar should find immediate support.
Good luck and stay safe