Omicron Threatens the Markets, but...

Omicron Threatens the Markets, but...

2021-12-09 • Updated

The news of the Omicron mutation came, bringing with it the worst Black Friday sell-off on Wall Street since 1931. How will the new variant affect the markets and the economy? What is its relationship to inflation and interest rate hikes, and how will it affect those things?

What is the impact of Omicron on the markets?

For once, the market reacted rationally and logically. Yes, the discovery of a new, perhaps more contagious, variant, and the immediate imposition of new travel restrictions by several governments created strong uncertainty about the global economy.  The markets witnessed a strong sell-off not seen since late 2020.

Although investors embraced the new normal, in which the coronavirus does not go away but can be controlled, a wave of precautionary selling occurred and profit-taking was inevitable.

Initial reports suggest that Omicron may be less deadly with mild to moderate symptoms, although it is highly contagious and spreads rapidly. If so, that could be positive for the markets. If we can make sure that Omicron is not a major threat, this will be an opportunity to buy the dip in the stock market with lower prices, especially in stocks associated with the reopening of the economy.

How will Omicron affect the economy?

Omicron's impacts will depend on how severe it is. If it is like the Delta variant in the third quarter, Goldman Sachs expects global GDP to fall by 0.4% in 2022.

The bank’s analysts identified four ways Omicron and the economy could go. A "false alarm" scenario, where the Omicron spreads less quickly than Delta and its economic impact is minimal. A “downside” scenario, where Omicron spreads more rapidly than Delta but isn't significantly deadlier, and has a modest economic impact.  A "severe downside" scenario, where Omicron turns out to be more contagious and deadly than Delta, leading to another wave of lockdowns and a major economic recession. The last one, the "upside" scenario, where Omicron spreads faster than Delta but is much less deadly so that the global economy could expand, even if it experiences some hard blows.

Will Omicron impact the tightening process and rate hikes?

Omicron hit the world just weeks away from the most important decisions that the major central banks had to make about raising interest rates. The Fed was likely to speed up the process of withdrawing stimulus by cutting back on bond purchases at a faster pace than the current one. The Bank of England was likely to raise rates, while the European Central Bank was planning how to reduce emergency bond purchases in the Eurozone.

Central banks are racing to control the wild inflation, which reached a three-decade high in the US, the highest in the history of the eurozone, and jumped to a 10-year high in the UK.

Nevertheless, Omicron may prompt central banks to question the timing and extent of rate hikes they should anticipate amid changing conditions. Markets have already priced in the expectation that central banks will start raising rates over the next year.

What will the Fed do?

The Federal Reserve Chairman Jerome Powell stated that "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". He continued, "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." Therefore, Omicron is expected to prevent the Fed from making any changes to its policy at its meeting this month. The emergence of Omicron complicated the decision-making on tightening and raising rates.

How will Omicron impact inflation and the supply chain crisis?

Omicron's impact on inflation is so far unclear and ambiguous. Two narratives can be achieved, only one of them would happen because they are complete opposites.

The first is that Omicron will cause inflation to rise further, as it may increase the concerns we currently have due to supply chain bottlenecks affecting production, thus raising the prices of goods and services. If we go back to lockdowns and the economy slows, growth and production will fall again and the supply crunch will worsen, which will keep inflation high for much longer.

Developed economies may not suffer a direct hit from Omicron, but they may take a hit from another side. Because of the unequal distribution of vaccines in developing countries, these economies have not recovered like the major ones. Developing countries are the core of vital supply chains for the global economy. Therefore, the slow pace of vaccination there is dangerous to the stability of the worlв economy because it hinders the revival of economic activities in developing countries, which hampers the supply chain. With the discovery of Omicron and the continued slow pace of vaccination, commodities and raw materials will continue to be scarce, and this may push the prices of essential commodities in Western countries more and more.

The second narrative is that inflation will decline with increasing concerns about Omicron, as demand will decline again as consumer confidence weakens and they stay at home for fear of catching an infection. This will reduce pressure on factories and service providers and decrease prices and inflation.

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