Scary as the Omicron Covid-19 variant seems, the Pavlovian freak-out in global markets may be the most frightening of all.
Obviously, the globe has much to worry about if this latest strain, first reported in South Africa, explodes globally. Even more so if it proves impervious to available vaccines.
But the speed with which investors jumped almost instantly to DEFCON 1 betrays a world economy that’s even more fragile than commonly thought.
Between coronavirus risks, inflation, supply-chain breakdowns and geopolitical tensions, few expected calm waters next year. But the Omicron scare underscores how on-edge global investors are as 2021 staggers toward an end.
Even the places punters might normally run for cover are proving shaky.
“Interestingly, both gold and Bitcoin flopped as well, and it seems neither is a haven or an inflation hedge when the flag really goes up,” observed Jeffrey Halley, senior Asia market analyst at OANDA.
The best advice may come from Fitch Ratings chief economist Brian Coulton.
“It’s too soon to incorporate the effects of the Omicron coronavirus variant into our economic growth forecasts until more is known about its transmissibility and severity,” he said.
“We currently believe that another large, synchronized global downturn, such as that seen in the first half of 2020, is highly unlikely, but the rise in inflation will complicate macroeconomic responses if the new variant takes hold.”
This new cloud of uncertainty is terribly timed for Chinese President Xi Jinping, Japan, South Korea and developing Asia. What all this means for China alone is already tantalizing markets. The odds that China can maintain above-6% growth just dimmed considerably.
The zero-Covid approach
That’s particularly so if Xi doubles down on Beijing’s zero-Covid approach.
“The spread of highly transmissible variants may ultimately make the strategy untenable,” says Mark Williams at Capital Economics. “But in the short-term, the authorities are more likely to double down.”
Williams notes that Xi may feel pressure to act even more assertively. “Intermittent,” he adds, “local lockdowns will continue to hit activity directly, while worries of being flagged as a close contact will keep many people at home.”
Morgan Stanley said in a report Monday that the Omicron strain may delay reopenings in China, Hong Kong and Taiwan that markets had already factored into investment plans.
“These economies have largely maintained a Covid-zero strategy,” Morgan Stanley economists argue. “With the emergence of this new variant, the near-term economic impact is likely to be limited – but this means any reopening efforts will likely be pushed out further, delaying a stronger rebound in consumption growth.”
Comments like those from Fitch’s Coulton will cheer some, while having others head for the exits. The real worry is that after nearly two years of battling a pandemic, and 13 years of recovering from the trauma of the 2008 crisis, the policy option cupboards are rather bare.
Central bank balance sheets are overloaded and government budgets already stressed.
“The scale of the policy support provided in response to the pandemic,” Coulton says, “has limited supply-side scarring from the pandemic in developed markets, relative to our initial expectations.”
However, Coulton notes, “recent increases in inflation will complicate any policy response to Omicron, which could have an inflationary effect if new lockdowns or voluntary social distancing constrain labor supply recoveries or exacerbate global supply chain shortages and bottlenecks.
“Hence, we believe central banks could be wary of delaying the normalization of monetary policy settings in response.”
The Bank of Korea is already tightening, of course. So is the Reserve Bank of New Zealand. Yet a move by the Federal Reserve to hit the brakes may be interrupted by Omicron as policymakers worry about kicking US markets when they’re down.
US economy under threat
On Monday, Fed Chairman Jerome Powell warned that the new Covid variant and increase in coronavirus cases threaten the US economy and complicate an already-uncertain inflation outlook.
“The recent rise in Covid-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation,” Powell told lawmakers.
“Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.”
Ian Shepherdson at Pantheon Macroeconomics notes that “if a clearer, and reasonably positive picture has not emerged by the time of the December 14-15 Fed meeting, then the Fed presumably will delay the decision to accelerate the pace of tapering.”
Some think the Fed is full speed ahead, with policymakers keeping their eyes on intensifying inflation risks. Economist Matt Luzzetti at Deutsche Bank thinks Powell’s team will increase the reduction in asset purchases to $30 billion from $15 billion per month.
Luzzetti also thinks the Fed might hike short-term rates in June, sooner than his earlier bet on July.
“However,” Luzzetti adds, “if the key data points over the next two weeks disappoint materially, market turmoil does not subside, or negative news becomes evident on the virus front, we will revisit this expectation.”
Until Omicron arrived, the International Monetary Fund expected 4.9% growth next year. Now, says Gregory Daco at Oxford Economics, analysts are left with a sliding scale of risks to come.
Tentative optimism
If Omicron results in “relatively mild symptoms” and vaccines prove effective, Daco reckons the variant could shave 0.25 percentage points off global growth next year. If the opposite is true and big lockdowns return, 2022 growth would come in at a lower 2.3% compared with the 4.5% Oxford Economics had previously expected.
There is some tentative optimism that markets have dialed back fears of the worst-case scenario, says economist Robert Carnell at ING Bank. “We are already seeing US Treasury yields moving off their Friday lows. Equities are being a little more circumspect, but FX in the region may also have overdone it and may show some signs of recovery.”
Yet as OANDA’s Halley notes, “Asia’s caution is understandable. Memories are still raw in the region of the delta wave earlier this year. Asia has a much higher beta to world trade and the global recovery than the US where the majority of GDP is internally generated.”
Halley adds that having moved heaven and earth over the past six months to get vaccination rates across Asia to better levels – and impressive ones, in some cases – “the prospect of them being rendered useless and trade suffering is understandably weighing on sentiment.”
Most economists agree that US President Joe Biden had it about right when he said Omicron is a reason for concern, not panic. Yet markets dealing with the PSTD of the last 22 months might find that easier said than done.