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Omicron variant underscores fragility of global recovery

Khatija Haque - Head of Research & Chief Economist
Published Date: 28 November 2021

 

Even before the South African scientists announced last week that they had identified a new Covid variant of concern, Covid infections were on the rise in Europe, the UK and in parts of the United States.  Several European countries have imposed new restrictions, with Austria going into a national lockdown for up to three weeks. Economists were already revising down their estimates for Q4 GDP growth in the Eurozone on the back of the impact these restrictions would have on economic activity.

The outlook for the US is more encouraging even with a rise in coronavirus infections there. Vaccine mandates are expected to boost vaccination rates, although court challenges mean that these apply only to federal government workers for the time being. Consumer spending remains strong and the labour market is showing sharp improvement.  The summer’s weak employment gains were revised higher and employment increased by more than forecast in October. Initial jobless claims fell to a 52-year low in the week to 20 November and – provided the momentum is sustained – the US economy looks to be on track to reach full employment around middle of next year.

This would allow to Fed to shift its focus squarely to inflation, which has continued to surprise on the upside.  While the central bank and most economists continue to expect inflation to slow next year, it will likely remain well above the Fed’s goal of 2% on average.  Several Fed presidents have already raised the possibility of accelerating the rate at which the Fed tapered its asset purchases as inflation concerns mounted, and before the Thanksgiving holiday, the market had priced in one rate interest rate hike by June 2022 and a further two increases before the end of next year. 

Then came the announcement last Thursday of a new variant of concern – subsequently named Omicron by the World Health Authority - which could be significantly more transmissible than the Delta variant, and against which vaccine or natural immunity may be less effective.  Scientists won’t know for at least another two weeks if Omicron is in fact more transmissible and resistant to existing vaccines. 

However, the market reaction on Friday was sharply negative across all risk assets, as governments around the world imposed travel bans on South Africa, despite the fact that the virus has already been found in Hong Kong, Israel, several European countries and the UK. European equity markets closed down between 4 and 5 percent on Friday, while US equities lost more than 2 percent in the half-day that the market was open Friday.  Unsurprisingly, travel stocks were among the hardest hit.

The flight to safety benefitted the Japanese yen and US treasuries. The US 10-year bond yield fell more than 16bp to 1.47%, and the market pushed back the expected start of the hiking cycle from June to July 2022, with a total of two rather than three rate hikes now priced in by the end of next year.        

Oil prices also fell sharply on Friday on the back of travel restrictions and the fear of tighter restrictions on movement more broadly.  Brent oil closed the week at under USD 73/b, its lowest level in two and a half months.  While this may eventually provide some relief for consumers, and central bankers worried about high inflation, it remains to be seen whether these lower prices are sustained.  OPEC+ is due to meet this week to decide on production increases for January and may decide not to increase production at all, which could provide some near-term support for oil prices.

Thin liquidity in the holiday-shortened week may have exacerbated the moves seen in financial markets last Friday.  However the market reaction highlights just how fragile the global recovery from the Covid-19 pandemic is. Vaccine coverage even in many developed economies remains below what is needed for herd immunity. Even with new treatments for coronavirus infections, health care systems can be overwhelmed by rising cases, leaving governments with little option but to reimpose restrictions which would slow growth or at worst, push economies back into recession. At the same time, those restrictions could worsen supply chain disruptions, adding to inflationary pressure even as growth slows.  

It is early days yet, and it is entirely possible that existing vaccines are still very effective at preventing serious illness, even if they don’t prevent infection, from the Omicron variant of the coronavirus. Booster vaccines adapted to be more effective against Omicron could be rolled out in a much shorter time frame than the first Covid-19 vaccines took to be approved and distributed last year. However, until there is broader vaccine coverage, not just in wealthy developed markets but in poorer developing countries as well, there will always be a risk of a new variant that threatens the gains the global economy has made.

A version of this article was published in The National on 29 November.