Market volatility to continue under the shadow of Omicron variant

Risk assets were hit hard on Friday when news of the Covid-19 Omicron variant made the headlines during the Thanksgiving Day holiday in the US.

Equity markets were rocked, with the S&P500 falling more than 2.2 per cent on November 26 – its largest one-day drop in more than nine months – while crude plummeted about 12 per cent per barrel as investors weighed up the potential of another global lockdown and its effect on oil demand.

That the new variant hit headlines amid a low liquidity, holiday trading environment exacerbated the sell-off as risk aversion combined with liquidity risk.

The reaction to Omicron has been “act first, ask later”, with travel curbs from the African subcontinent quick to be introduced and some countries shutting borders altogether.

Along with Israel and Morocco, Japan was the first Group of Eight nation to announce a border closure to non-resident foreigners early Monday morning.

With the World Health Organisation deeming it “a variant of concern that carries higher risks than other viruses”, expect the uncertainty in markets to continue indefinitely as Omicron will dominate and drive risk moods in the short term.

What will be particularly interesting is if and how this new variant will affect future central bank policies.

Governments are clearly more sensitive to new variants and are ready to act far more swiftly, as seen by Japan’s actions on Monday.

One school of thought would suggest this could potentially delay further tapers to current monetary policy and tone down hawkish rhetoric to future interest rates.

Judging by the reaction of the US dollar to the new variant, this could be the case. The US dollar, traditionally seen as a safe haven that excels in a risk-off environment, sold off through Friday’s trading session.

This would suggest to me that markets were perhaps pricing in the potential for the Federal Reserve Bank to tone down its hawkishness towards future tapers and interest rate rises. This is also why US Treasury yields dumped off on Friday – with lower expectations of future rate hikes, bond yields fall and vice versa.

The underlying themes that we focused on before Omicron emerged remain the same, albeit overshadowed by the new variant.

Central banks will continue to remain sensitive to inflation risks. Minutes from the last Fed meeting reiterate that it is willing to tighten policy faster if inflation continues to run hot.

You may recall that the Personal Consumption Expenditure (PCE), the measure of inflation that the Fed follows most closely, increased to 5 per cent. This Friday’s non-farm payrolls will also be a key release – payrolls are expected to show a gain of 550,000 new jobs in November, with the overall unemployment rate improving to 4.5 per cent from a previous reading of 4.6 per cent.

Across the pond, EUR/USD on the Dubai Gold & Commodities Exchange dropped below 1.12 for the first time since July 2020.

Weakness is expected to continue for EUR/USD in the weeks ahead. Fundamentally, European Central Bank president Christine Lagarde has warned that monetary policy tightening could choke an EU recovery and minutes from the most recent ECB meeting suggested that the central bank would maintain “sufficient optionality in the calibration of its monetary policy measures”.

Coupling these dovish undertones with the emergence of the Omicron variant means that the outcome of the December ECB meeting will be even more uncertain.

And finally this week, Opec will discuss oil production with its non-Opec partners. While the group is largely expected to keep its current 400,000 barrels per day increase in place, its views towards future demand could see some additional volatility coming into US crude gauge West Texas Intermediate and global benchmark Brent contracts on the DGCX.

Gaurav Kashyap is head of futures at EGM Futures. The views and opinions expressed in this article are those of the author and do not reflect the views of EGM Futures