New strain of covid may cause a 180 degree turn for central banks, inflation and oil

The threat of the new South African variant of the coronavirus, which the WHO has dubbed Omicron, and its potential partial resistance to vaccines – which is still being studied – represents a 180-degree turn for the market. It has moved from the prevailing concern about inflationary pressures and interest rates to a scenario of new confinement. The consequences for the main market variables would be cheaper oil, relief for inflation, a new delay in the rate hikes, but with the aggravation of a truncated economic recovery.

New variant of covid, new potential scenario for the economy and markets. Until there is greater certainty about the extent and aggressiveness of the latest South African variant, it will be impossible to foresee its impact on markets and the economy, but taking into account that it is possible that they are resistant to current vaccines – although it is not yet known in what a measure-, this would suppose a new scenario for the markets and the economy.

In a matter of hours, the outlook for the markets and the economy could be turned upside down. We would go from a scenario in which inflation was the main threat, with unstoppable oil prices (they have forced the US to announce the largest release of reserves in its history) and the first rate hikes just around the corner to another. almost radically opposite. Commodity and interest rate futures are showing some clues as to what the new scenario could look like if the new strain of covid is confirmed to be more contagious and resistant, something that is still being investigated.

The first piece of this new scenario would be in the oil market. Futures for Brent (benchmark crude in Europe) and West Texas (benchmark in the US) have fallen by more than 10%. In dollars, this decrease represents the loss of more than 8 dollars in one session, which would leave the barrel below 70 dollars with the WTI. The price of natural gas, which is in the eye of the hurricane in Europe’s energy crisis, is also suffering. Futures correct around 4% and fall below 90 euros per Mwh.

The threat of an immune variant to vaccines would mean a plummet in energy demand in the face of the possibility of harsh lockdowns being extended. Oil and gas have been two of the main drivers of inflation to date. So cheaper energy would detract from inflationary pressures in the weeks and months to come.

This week the member of the ECB Fabio Panetta explained that a high percentage of current inflation corresponded to import prices. For the European Union, it is the same as saying that prices are at the mercy of energy, due to foreign dependence.

The fall in the price of crude could continue if countries begin to implement more border restrictions to prevent the spread of the new strain, limiting international mobility and weighing on fuel consumption. The worst scenario would be the implementation of limitations on internal mobility, which would be a serious blow to gasoline and diesel consumption.

The fall in energy and greater uncertainty about the economy are in turn cooling inflation expectations in the euro zone or the US. These expectations are closely followed by central banks, which seek to keep them anchored near 2%. Until now, one of the risks was that they would de-anchor upwards, that agents predicted that central banks were going to lose control of inflation, but this new variant has the potential to ‘put out’ that fire (perhaps by pouring too much water) given the forecast of weaker energy prices and more moderate demand.

With no rising inflation on the horizon, the pressure for central banks to raise rates is reduced. The market was discounting an interest rate hike from the European Central Bank for 2022, which would leave the rate on the deposit facility at -0.4%, compared to -0.5%. This rate hike predicted by the markets has evaporated in hours. Eonia one-year futures, an interest rate index of the euro zone (which is also used to discount the next movements of the ECB) have taken a significant turn in a few hours, erasing almost all the rate hikes they were discounting.

The future of the Eonia reflects the fall of the interests in the market due to the impact of the new strain. Expectations of Bloomberg They relax the rate hikes by the ECB, too, compared to last week. Now they even rule out a possible rise by the end of 2022 up from 100% at the beginning of last week. Ángel Talavera, chief economist at Oxford Economics for Europe, joked on Twitter wishing luck to all those who predicted or bet on an interest rate hike in the Eurozone in 2022.

In the US, a response to inflation is also complicated

At this time, the CME FedWatch indicator indicates that the market anticipates the first increase, the first increase of 25 basis points in the price of money by June 15, 2022 and discounts a total of up to three rate hikes next year. . That said, the situation may change if the new variant takes a toll on both confidence and infections in the world’s largest economy.

If the new strain ends up in the worst possible scenario – that it is resistant to vaccines, which would take a few months to update – “it will nullify the need for monetary adjustment as the market pointed out,” commented Mizuho International analysts. These experts believe that central banks could delay expected rate hikes by about six months.

“We hope that central banks will be more understanding of the situation before eliminating any accommodative measures,” said Pooja Kumra, a strategist at Toronto-Dominion Bank, in an interview on Bloomberg Television. “The next two weeks we could continue to see the pressure relax.”

The potential scenario that presents itself will complicate the political response. The threat of a new, more serious variant of the virus may be a reason for the Federal Reserve to postpone its plans to raise interest rates until the outlook clears. The US central bank is scheduled to take place on December 14 and 15.

Some investment desks such as Goldman Sachs, anticipated before the situation presented today in markets around the world, that the Fed could accelerate its program of asset cuts. Currently the entity reduces its purchases at a rate of 15,000 million (10,000 million dollars in Treasury bonds and 5,000 million dollars in assets backed by mortgages) per month. Given the circumstances, any announcement in the making could be quarantined pending what may happen in the next few days.

Going into economic matters, this South African variant, as of this Friday known as Omicron, has the potential to limit international flows of people. Perhaps this time the governments are anticipating the situation and the new South African strain is being prevented from spreading as it has happened with previous strains, but even so the firewalls implemented to prevent its spread will have an impact on the transport and tourism sector.

A good example is the sharp falls in the stock market of airlines and other tourism-related firms. The Spanish Ibex 35 or the Athens Stock ExchangeIndices with strong exposure to these sectors are suffering the greatest corrections within the European indicators. In contrast, the German Dax 40, the Danish stock market and the Belgian stock post the most moderate losses.