Omicron Fears and Powell’s Hawkish Shift Roil Markets

The discovery of the new omicron coronavirus variant and the Fed Chair’s more hawkish tilt on tapering, rates, and inflation have injected volatility and fear into markets – but the outlook is uncertain.

Omicron Variant Fears

At the end of last week, the Republic of South Africa reported the discovery of a new coronavirus variant, named omicron. Daily confirmed coronavirus infections in South Africa have increased dramatically in recent days. Initial reports on the omicron variant suggested that the variant may be more inherently infectious than other virus variants, but the greatest concern was raised over its potential ability to infect vaccinated people due to the very large number of observed mutations in its binding system.

Many countries quickly moved to shut down travel from South Africa and other nearby African nations, but it was soon discovered that the virus is present in several countries, some of whom have observed community spread. While speedy measures have been taken to try to defend against the entry of the omicron variant, recent experience suggests it will likely be impossible to achieve.

This bad news arrived against a backdrop of increasing rates of coronavirus infections in Europe, where despite high levels of vaccination, daily new cases in some countries are reaching their highest ever levels. Some countries have brought back lockdown-style restrictions to combat rising infections.

Markets now face the question – how bad will omicron be? A South African governmental health advisor stated that the symptoms are typically mild, although this is far from certain, as South Africa has a low level of vaccination, so its data is hard to mine. The vaccines most used in South Africa also tend to have shown the lowest rates of clinical success in trials compared to other vaccine types.

The CEO of Moderna stated that he has no doubt that existing vaccines will have notably lower levels of success against preventing omicron infection.

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Powell Hints on Earlier Taper, Inflation

In testimony before Congress yesterday, the Chair of the Federal Reserve Jerome Powell said that if the omicron variant does not have a strong negative impact, it would be wise to taper more quickly than has been planned. Powell also dropped his description of recent inflation as “transitory.” This is clear evidence that Powell’s monetary policy has been recalibrated to a more hawkish tilt, meaning that the Federal Reserve is likely to stop propping up the market with asset purchases and finally hike rates for the first time in years sooner than had been expected.

How Did the Markets React?

Both the initial news about the discovery of the omicron variant, the comments from Moderna’s CEO, and Powell’s testimony roiled markets. All sent stock markets lower. The Forex market reacted in a more mixed way. We have seen more volatility and more risk-off price movements, but the movements are neither very strong nor uniform across asset classes. The US dollar has weakened, despite the Fed’s seeming hawkish tilt, which is strange as it should also be acting as a safe haven.

What Does This Mean for Traders?

Traders should be aware that fear levels are rising, but markets are far from full-on risk-off panic. The jury is still out on the economic impact of omicron. What has been notable, is that we began to see price movements that were reminiscent of the early days of the coronavirus panic of March 2020: plunging stock and commodity markets, with commodity currencies falling, and the Japanese yen and euro rising as safe havens.

If the omicron variant proves strongly evasive to vaccines and sharply increases the number of seriously ill requiring hospital treatment, we will probably see a repeat of what happened in the markets in March and April 2020, as there will likely be more lockdowns and disruptions to trade. If this were to happen, it would also call the more hawkish monetary policies that many central banks are inching towards into question, creating further confusion.

If omicron turns out to be a lot of fuss about nothing, and it has little economic impact, it may be that risk sentiment bounces back and this is just a small dip in a longer-term risk off trend that has been running since the summer of 2020.

Traders will be well advised to lighten their positions, consider taking profits, and to trade cautiously and with small position sizes until the omicron outlook becomes clearer. Once that happens, there will probably be money to be made from following the trend.

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