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Omicron brings uncertainty back into currency markets

December 2021

Omicron, the thirteenth mutation of COVID-19, has waylaid the return to normality that many hoped for this month.

The variant, first identified in southern Africa where it has taken hold, has been detected in passengers arriving in Australia, Japan and the Netherlands among other countries, prompting fears economies would have to go into shutdown again. Flights from affected areas were quickly cancelled.

Markets mauled

When the World Health Organization declared Omicron to be a “variant of concern”1 on November 26, markets were instantly roiled, fearful that the economic reopening would be derailed.

The selloff on the news was the largest of the year for US equities2 with the blue chip Dow Jones index dropping 900 points in the half day of trading over the Thanksgiving weekend.

Oil prices lost over 12% as traders fretted about border closures and transport restrictions reducing demand for oil.

A flight to the safety of US government bonds pushed prices up and yields down to 1.48% from 1.64% for the benchmark 10-yr US treasury, reversing a trend of rising bond yields due to increasing inflation.

Safe-haven currencies the Japanese yen, Swiss franc and US dollar all lifted while growth currencies (those linked to global demand for commodities) got a battering. The Canadian dollar fell by more than 1.4% against the majors, while the Australian dollar and New Zealand dollar got hammered against the Japanese Yen in only one day by an astonishing 2.64% and 2.34% respectively on November 26.

After the shock, some perspective

The good news is that countries are becoming experienced at dealing with 2nd and 3rd waves, so the economic hit is not as profound as at the start of the pandemic. The bad news is that we still don’t know how problematic Omicron might be. The CEO of drug manufacturer Moderna warned that current vaccines may not be as effective against Omicron and that it would take months to develop and ship a vaccine that could counteract the high number of mutations on the protein spike the virus uses to infect human cells.3 Those comments caused US stocks to sink, sending the Dow Jones Industrial Average and the broader S&P 500 share indexes 1.9% lower. The tech-focused Nasdaq lost 1.6%. Similar declines were felt in Europe and Asia.

How Omicron changes the medium term narrative is still anyone’s guess.

Already the dominant strain in southern Africa, Omicron seems to spread quickly. In Norway, 50 people were likely infected with the Omicron COVID strain at a Christmas party attended by an employee who had returned from Cape Town4, prompting a new wave of restrictions in Norway’s capital.5

Winter was always going to be a test for how northern hemisphere countries would cope with COVID-19, and many countries were seeing a return to normality. In the UK, real-time data from restaurant reservations and online job adverts were well up on the same day last year, while retail footfall was just 8% below the same day in 2019, so if Omicron is more vaccine resistant and fast spreading, that would be likely to damage the economic recovery.

The Delta strain is also still rampaging in some countries, particularly those where vaccine hesitancy has prevented full coverage. In the last week of November, France saw its highest one-day tally since April with 47,000 infections, while Germany’s coronavirus death toll passed 100,000. It has meant stricter public health measures in the region, with people now needing to have proof of vaccination or recovery from the virus to access public transport, shops, restaurants, bars and clubs. Christmas markets have been closed for the second winter in a row.6

Omicron as a disruptor to central bank policy

This disruption comes at a time when inflation has been of increasing concern for central banks. As noted in last month’s article7, global supply chain issues and constrained production amid surging demand is resulting in spiking prices. We are seeing central banks start to tighten monetary policy, with the US Federal Reserve presaging that it would end its liquidity injecting bond buying program earlier than expected after an inflation reading of 6.2% in October. Minutes from the Fed also indicated members were prepared to start raising interest rates if inflation persists.8

The good news is that countries are becoming experienced at dealing with 2nd and 3rd waves, so the economic hit is not as profound.

Europe, in contrast, still seems committed to ultra-low interest rates despite inflation surging to the highest on record with prices jumping 4.9% in November — although a large factor in the soaring costs was a 27% jump in energy prices year on year.9 European Central Bank president Christine Lagarde has been of the view that inflation is “transitory” and the delicate balance she will need to strike is how to manage the compounding issue of Omicron plus Delta against inflation fears. This divergence in sentiment over inflation could leave the euro undervalued against other major G7 currencies next year.

How Omicron changes the medium term narrative is still anyone’s guess. While reports of cases are causing markets to swing wildly, there is still not enough data to tell if this mutation is significantly worse than Delta. Until that becomes clearer in the following weeks as infections rise, we could expect more volatility.

Depending on Omicron’s severity, there are three possible scenarios to watch for. The scenario similar to the initial stages of the pandemic involving lockdowns and low interest rates; the current one where a watchful eye on inflation demands a softly, softly approach; or one where Omicron’s wave shows vaccines and health responses have worked and life can essentially go back to normal – under that scenario we could expect continued inflation and rates to rapidly rise.

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