Whatever we all used to think
‘Bout how growth might rapidly shrink
If Covid spread quicker
Prepare for the kicker
A new strain that spreads in a blink
While the plan was to let you all digest your Thanksgiving meals in peace, unfortunately, the news cycle is not prepared to cooperate. Risk is waaaayyyyy off this morning as news of a new strain of Covid, B.1.1.529, has been identified in South Africa, but also in Botswana and Israel, albeit only a literal handful of cases so far, but whose attributes may be that it is not going to be able to be addressed by vaccines. So the market reaction has been to sell any risk asset they hold, which has resulted in a serious risk-off session with equity markets around the world much lower (Nikkei -2.5%, Hang Seng -2.7%, Shanghai -0.6%, DAX -3.0%, CAC -3.75% and the FTSE 100 -2.9%), bond markets ripping higher with yields tumbling (Treasuries -9.6bps, Bunds -5.5bps, OATs -5.1bps, Gilts -10.5bps and even JGBs -1.5bps) and oil getting trashed (-5.3%). Aside from bonds, the only other things higher this morning are gold (+1.0%) and the yen (+1.1%). That’s not strictly true, the euro has performed better than you might have expected, rallying 0.7%, although most EMG currencies are under real pressure, as are the commodity linked G10 currencies like CAD (-0.9%), AUD (-0.55%) and NOK (-0.4%).
US futures are also pointing sharply lower (DOW -2.0%, SPX -1.6%, NASDAQ -1.0%), so be prepared for some red on the screens here as well. The emerging consensus is that lockdowns are coming back, with Belgium imposing some overnight already, and travel bans are back with Israel and the UK already banning flights from South Africa.
Aside from the obvious health concerns that we will all be reevaluating; the point of this note is to discuss the impact on markets. Well, the idea that the Fed is going to be raising rates more rapidly has been tossed aside, with talk that tapering is not only not going to accelerate, but potentially stop. So, they will have reduced purchases by $15 billion/month and that will be it. Recall, just Wednesday there were two 25 basis point rate hikes priced into Fed funds futures curves by the end of 2022, with a third due for February 2023. Already one of those rate hikes has been priced out and if the news doesn’t improve soon, I would look for the others to go away as well. If we are entering a new phase of Covid restrictions, the question will be how much more money governments around the world are going to throw at the problem, not when they are going to start removing accommodation.
So, the quick analysis is that inflation will quickly fall to the wayside as a concern around the world as governments everywhere react to this latest medical risk. Of course, at this point, it no longer matters why prices are rising, it is simply the fact they are rising and that expectations for them to continue get further entrenched that is the problem. Reading through comments from various companies in their recent earnings calls shows that most of them are anticipating raising prices to cover costs as frequently as quarterly. Once again, this implies that holding ‘stuff’ rather than paper assets is going to be the best protection one can have for a while yet.
It is still too early to estimate how this new Covid strain will ultimately impact economies which is entirely dependent on government responses. But if recent history is any guide, I would expect that the playbook remains; more fiscal spending, more monetizing of debt and higher inflation amidst platitudes of just how much those governments care about you, their citizens.
Also, do not be surprised if all those best laid plans of companies returning to offices get waylaid once again.
In the end, the reason companies hedge their FX exposure is to help reduce the variance in earnings, whether by moderating cash flow swings or balance sheet revaluation. It is because markets respond to news of this nature in such extreme measures that hedging makes sense and that is not about to change.
But also, B.1.1.529 is yet another nail in the coffin of just-in-time manufacturing processes. Just-in-case is going to become the new normal, with higher inventories in order that manufacturers and retailers can satisfy client demand, and that is a permanent change in pricing. Any thoughts that inflation is going to go back down to sub 2% for an extended period are going to run headlong into reality over the next year, and it won’t be pretty.
To sum it up; risk is worthless today, hold havens. As to all the tomorrows, prices will tend higher for a much longer time regardless of what bond markets seem to indicate. Those markets no longer offer signals as in the past due to central bank interference.
And with those cheery thoughts, enjoy Black Friday and a full edition will be out on Monday.
Good luck, good weekend and stay safe