A month of ups and downs that ended down
Then came the downturn: equities faltered amid as the fifth Covid wave hit some European countries particularly hard. The final straw was news of the Omicron variant on ‘Black Friday’, 26 November (this also happened to be Thanksgiving weekend in the US, which meant market liquidity was particularly poor).
The news provoked a sharp and widespread equity selloff (-2.2% for the MSCI AC World), with a further 1.6% loss on the last day of the month.
New (nasty?) kid on the block
The new Covid variant weighed on investor and government confidence. The Omicron strain, first identified in South Africa, is potentially more transmissible than Delta and has characteristics that could make it vaccine-resistant. Test results are due shortly. Laboratories said existing vaccines could be adapted in less than six weeks and be available in 100 days.
Government travel bans, in addition to the tougher restrictions already in place in several European countries to deal with the fifth wave, revived investor concerns about the risk of a sudden slowdown in the global economy.
Over the month, the MSCI AC World fell by 2.5%. The MSCI Emerging Markets index shed 4.1%, with larger losses for emerging markets exposed to the abrupt fall in oil prices, amid a stand-off between the US (which released some strategic oil reserves) and other oil-producing countries (which are increasing output only gradually). Worries over global growth added to the downward price pressure.
To cap it all, the month ended with a much less dovish tone from US Federal Reserve Chair Jerome Powell. His comments (prepared admittedly prior to the news on the discovery of the Omicron variant) to the US senate on 30 November reinforced expectations of US monetary policy tightening and weighed on financial markets. US equities still outperformed, with the S&P 500 index only losing 0.8% from the end of October while the NASDAQ composite finished slightly up.
European equities were hit by the restrictions across the continent to combat soaring Delta infections. The EuroSTOXX 50 index fell by 4.4% to its lowest since mid-October. The Nikkei 225 index declined by 3.7%. Globally, among the sectors, the main underperformers were energy and financials stocks, which suffered as yield curves flattened.
A less market-friendly version of the same Fed chair?
Fed Chair Powell’s comments on 30 November suggest he has shifted away from the view that inflationary pressures in the US economy will be transitory. This fuelled market expectations that the federal funds target rate (at 0-0.25% since March 2020) could be increased as early as in 2022. Powell, (whose reappointment by President Biden was announced on 22 November), stressed the damage that inflation does to household purchasing power. Incoming Fed Vice-Chair Lael Brainard echoed that message.
The Fed chairman also said he would propose an acceleration of tapering at the 15 December monetary policy meeting. This would involve stepping up the reduction in monthly net asset purchases (currently at USD 120 billion/month) from USD 10 billion for Treasury securities and USD 5 billion for agency mortgage-backed securities (MBS) in November and December.
The newly hawkish tone came just as economic indicators showed an acceleration in domestic demand, suggesting a rebound in growth in Q4 after the modest increase in Q3. At the same time, inflation has continued to accelerate to its highest pace since 1990. This is beginning to weigh on consumer confidence.
The European Central Bank has other fish to fry
In November, the ECB calmed market expectations of a rise in its key interest rates by arguing that the conditions for monetary tightening would not be met in 2022 since the current rise in inflation was ‘temporary’. The German 2-year Bund yield fell from -0.59% at the end of October to -0.74%.
A decision by the Bank of England contributed to the fall. Unexpectedly, the BoE did not raise its key rate as expected on 4 November. Market expectations of the ECB raising policy rates from 2022 quickly adjusted, while ECB officials again stressed that such a tightening would not be justified – a clear divergence from the Fed’s view on inflation.
‘Peripheral’ eurozone bond markets suffered from continued uncertainty over the outlook for the ECB’s Pandemic Emergency Purchase Programme (PEPP). Some Governing Council members questioned the need for an additional programme after the PEPP ends in March, while others suggested that monetary support would remain strong. This left some in the market thinking that the ‘normal’ EUR 20 billion asset purchase programme could be topped up with, on average, a further EUR 20 billion a month.
Always look on the bright side of life (a little tune to end the year)
The latest Covid and monetary policy developments are clouding the view for investors, and the current phase of volatility is likely to continue at least until the end of the year as transaction volumes are likely to fall.
The Omicron variant has raised concerns about the health situation. Supply-side bottlenecks might not ease if tighter social and economic restrictions are imposed. However, if such restrictions hit services consumption, it could slow inflation. Investors should also consider the possibility that Omicron will turn out to be the first Covid variant to cause a less serious form of the disease.
On the monetary policy side, at this stage central banks do not seem to think that Omicron is likely to radically change their analysis of the economic outlook. Indeed, for several months now, the consequences on economic activity of lockdowns of varying severity have been limited – and temporary.
Even if the concerns persist, they should not call into question the favourable medium-term scenario. Domestic demand is solid, supported by a continued improvement in employment, and appears able to withstand a gradual withdrawal of monetary support programmes.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.