Global equities (as measured by the MSCI AC World index) took a dip last week with shares off by 1.3%. In the U.S., the NASDAQ dropped 2.6% while the Dow Jones slipped 0.9%. While fears of the Omicron variant would normally boost technology shares, several companies’ shares fell as the odds of renewed U.S. lockdowns appeared to weaken throughout the week. The S&P 500 fell by 1.2%. Non-U.S. markets were mixed with European stocks falling 0.5% while Emerging Market stocks eked out a 0.2% gain. The 10-year U.S. Treasury yield slid from 1.47% to 1.34% on the prospect of weaker growth.
The Omicron COVID-19 variant has sent financial markets on a rollercoaster ride over the past week. The old market adage that, “the market hates uncertainty,” seems an apt description for the current environment. However, early rumors that the variant may be more mild than previous variants is encouraging. Investors will know more when vaccine effectiveness results are released over the next few weeks.
Although Omicron remains a risk, Federal Reserve policy may be the larger driver of equity markets in 2022. Last week, Fed Chair Powell told the U.S. Congress that the Fed may need to end its bond purchase program a few months earlier than telegraphed and that it is time to retire the word “transitory.” By doing so, the Fed aligned itself more closely financial market pricing. The November consumer price index may drive markets later this week.
The Week in Review
The Institute for Supply Management’s (ISM) manufacturing index rose 0.3 points to 61.1 in November. New orders, production, and employment growth each broadened. Importantly, delivery delays and price pressures eased a bit. Commentary from chemical and plastics producers pointed to improving supply chains. Separately, the ISM services index jumped 2.4 point to a record high 69.1. Business commentary suggested that strong demand continues to outpace supplies and that inflationary forces were still visible in the marketplace. When combined, the two national indices point to strong U.S. economic growth heading into year end.
Total U.S. vehicle sales fell from an annualized pace of 12.99 million units in October to 12.86 million units in November. U.S. auto sales remain a primary example of supply chain problems with annualized sales still about 4 million units below 2019’s annual pace. Importantly, there are some early signs that the semi-conductor shortage is starting to ease, which should boost auto production and provide much needed vehicle inventory.
Oh C’mon Omicron
The discovery of the new Omicron COVID-19 variant has taken financial markets on a rollercoaster ride over the past week with the Dow Jones dropping sharply one day and rallying the next as investors grapple with uncertainty (see figure 1). However, the Omicron variant was just one of several key developments recently with Fed Chair Powell suggesting to Congress that the Fed may eventually decide to accelerate its pace of bond purchase tapering and that the word “transitory” should probably be retired. Seemingly suggesting that inflation is likely to be more persistent than originally thought. Let’s start with what we know and what we don’t know about Omicron at this stage.
The Omicron variant has approximately 50 mutations from the original strain with over 30 mutations occurring on the protein spike, which is what vaccines target. It is believed that the high number of mutations may help the variant to elude current vaccines. While there are some early rumors that the current batch of vaccines will have at least some effectiveness against the Omicron variant, that is just speculation, and it will likely be another week or two before official results on vaccine efficacies will be released. We suspect that an efficacy rate that is above 70% or so would likely be welcomed by markets. We would also point out that one benefit of the mRNA technology used in several vaccines is that it can be sequenced quickly with booster shots possibly available in early 2022. That should help limit the downside in financial markets should the current vaccines prove less effective. Importantly, the global population has learned how to fight back against the virus and that has enabled the global economy to be less impacted with each subsequent wave of COVID. Just like an earthquake, it is not surprising to see aftershocks with new mutations that remind us of the tragedy we just experienced, but aftershocks are usually not as powerful as the original earthquake.
We think it is also important to remember that over 60% of the U.S. population has been fully vaccinated and will likely have at least some protection from infection and a return to the lockdowns of March and April of 2020 is highly unlikely with 2022 U.S. mid-term elections quickly approaching. In addition, President Biden’s Chief Medical Advisor Anthony Fauci recently stated that, “Thus far, the signals are a bit encouraging” regarding Omicron’s severity and South African hospitalizations appear to be held in check despite the arrival of the new variant. This could be a critical development as lockdowns would be less likely if healthcare systems can avoid becoming overwhelmed.
In terms of what it will likely mean for financial markets, the most obvious course of action is a partial reversal of the reopening trade with the most beaten down sectors like airlines possibly taking longer to recover (see figure 2). Although there are also some potential silver linings that investors should consider like lower energy prices (see figure 3), which could drag down inflation prints in the next couple of months.
The Fed Catches Up with the Curve
This comes at a time when the Federal Reserve has suddenly taken on a more hawkish tone with Fed Chair Powell stating to Congress recently that it is time to retire the word “transitory” and that the Fed may decide to end its bond purchases a few months earlier than previously telegraphed. This shouldn’t be a total surprise to financial markets with the Fed having only ordered the current pace of tapering for November and December and with Fed Vice-Chair Clarida having already stated that the Fed may need to consider accelerating the pace of tapering.
However, Chair Powell comments before Congress came a time when financial markets were already volatile due the Omicron variant. The timing could have probably been better. As we have mentioned before, the Fed is often “behind the curve” until they are not. Meaning that Fed officials can catch up to the curve literally whenever they want, but with a risk that the sudden shift in policy unsettles markets, which is essentially what Chairman Powell did before Congress. If the Fed decides to announce a faster pace of tapering (perhaps a rate of $30 billion a month instead of the current $15 billion a month rate) at its December 14-15 meeting, it should be viewed as the Fed increasing its policy options to fight inflation should it be needed. It seems unlikely that the Fed would want to raise rates while continuing with bond purchases as it would be seen as counter-productive. In our view, the Fed better aligned itself with the market last week.
Time to Pick Up the Can
Apart from Omicron and the Fed, the U.S. Congress decided to pass a continuing resolution to fund the Federal government through mid-February and will need to address the debt ceiling in short order with Treasury Secretary Janet Yellen saying that the unofficial debt ceiling date when the U.S. Treasury can no longer fund all of its obligations is December 15th. However, Citi Research suspects that the actual “hard” debt ceiling date is probably in early January with incoming tax revenues likely to push back the date a bit. Either way, Congress will need to act or U.S. stocks could eventually start to head lower as the date approaches. With the White House and Congress having acted 98 times since the end of World War II to modify the debt ceiling, we see no reason to believe that this constant game of chicken will end any different this time with policymakers likely to swerve yet again at the last minute to avoid potential disaster. A U.S. government default is a tail risk quickly approaching, but it is a very, very low probability event.
The U.S. Economy Appears on Track for a Solid Fourth Quarter
Although the U.S. employment report showed the economy adding just 210,000 jobs in November – the weakest print in 2021 thus far – other economic data continue to point to an economy that is accelerating in the fourth quarter. For example, within the very same report, the household survey showed the economy adding back 1.1 million jobs and the unemployment rate falling from 4.6% to 4.2% (the unemployment rate calculation uses the household survey data not the employment survey data). In addition, the Institute for Supply Management’s (ISM) services index, a barometer for economic activity in the services side of the economy, jumped to a record high 69.1 in November. This level is consistent with very solid economic growth. While the Omicron variant could eventually weigh on economic growth, for now, the U.S. economy appears to be on an uptrend with the widely followed Atlanta Fed GDPnow tracker climbing from 8.6% in the fourth quarter to 9.7% after the release of the ISM services index and construction spending data.
|Index||Weekly Chg (%)change in percent||YTD (%)year to date change in percent||12 Months (%)12 month change in percent||Div. Yield (%)division yield in percent|
|Instrument||Weekly Chgchange||YTDyear to date||12 Months (%)12 month change in percent||Level|
|10-Year Treasury Yield (%)||-13 bps||42.9 bps||43 bps||1.34%|
|Index||Weekly Chg (%)change in percent||YTD (%)year to date in percent||12 Months (%)12 month change in percent||Div. Yield (%)division yield in percent|
The Week Ahead
|12/7||8:30||Nonfarm Productivity||3Q F||-4.9%||-5.0%|
|12/7||8:30||Unit Labor Costs||3Q F||8.3%||8.3%|
|12/8||10:00||JOLTSJob Openings and Labor Turnover Survey Job Openings||October||10469k thousand||10438k thousand|
|12/10||8:30||CPIConsumer Price Index YoY year on year||November||6.8%||6.2%|
|12/10||8:30||CPIConsumer Price Index Ex Food and Energy YoY year on year||November||4.9%||4.6%|
|12/10||10:00||U of Mich.University of Michigan Sentiment||December P||68.0||67.4|