Since South Africa’s discovery of the omicron COVID-19 variant over a week ago, the new virus strain has been detected in at least 30 countries around the world. As of Sunday, the U.S. had confirmed cases in 15 states, with that number expected to climb. However, of the 90,000 to 100,000 new daily cases, the omicron variant is currently responsible for an extremely small fraction relative to the delta variant.
Critical questions around the omicron variant’s virulence and its evasiveness from vaccines will linger for weeks. Work is underway to bring clarity to these issues; however, global markets are responding to the uncertainty by turning decisively risk-off. U.S. equites added to their recent drawdown with the S&P 500 falling roughly 3.4% since Thanksgiving. Simultaneously, U.S. yields beyond 2-year maturities have declined as investors flee to higher-quality assets. The drop in yields also suggests the omicron variant is fueling an increasingly downbeat outlook for global growth.
But, new COVID-19 developments are not solely to blame for the shift in investor sentiment. In our latest Fixed Income Perspective, we discussed the sequential assumptions the market is relying upon to paint a darker growth picture. In short, the assumptions are that a new wave of the virus threatens to further disrupt the supply chain, add to inflationary pressures, and force an overly hawkish Federal Reserve (Fed) response that damages (or even ends) the U.S. recovery. This “domino effect” narrative hinges on a major omicron-related disruption, which may not come to pass. Additionally, we continue to see supply chain improvements and expect a very cautious approach to tightening from the Fed. Cooler inflation readings around the time the Fed completes its tapering process should allow the Fed to stay patient and data-dependent as opposed to moving into auto-hike mode as the market currently fears.
A look back
- The S&P 500 fell 1.2% last week, resulting in a 3.4% drawdown since the Thanksgiving holiday. Stock volatility gauges are sitting near a 10-month high.
- 10-year U.S. Treasury yields fell another 0.14% last week to 1.34%. The 2/10-year yield curve fell to its flattest trajectory since December 2020, suggesting fears over omicron’s economic impact and the Fed’s reaction function.
- Fed Chair Powell and Treasury Secretary Yellen discussed the more persistent nature of current inflation, potentially teeing up faster tapering.
A look ahead
- Market participants will remain on edge awaiting further information around the omicron variant’s health and economic threats. Key questions –Illness severity and response to existing vaccines.
- Fed officials enter their quiet period ahead of the December 15 Federal Open Market Committee meeting, where policymakers are expected to evaluate the current pace of tapering.
- Economic releases: November Consumer Price Index, Univ. of Michigan Sentiment, MBA Mortgage Applications, Trade Balance, Initial Jobless Claims.
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