Volatility picked up in markets this week as the Fed’s Jerome Powell took a hawkish twist and the new Covid variant Omicron added new uncertainty to the growth as well as inflation outlook. The stock market VIX volatility ‘fear gauge’ increased to the highest level in 10 months and German 10-year yields dropped to -0.35%, the lowest level in two months. EUR/USD bounced higher to above 1.13 despite hawkish Fed comments but it probably reflects a temporary correction as investors are quite long the USD. The common factor in markets also seem to be a squaring of positions heading into year-end to protect positions in the midst of rising uncertainty. Oil prices has dropped sharply to just below USD70 per barrel on concerns over less travelling over the winter amid new covid waves and restrictions. It’s a drop of more than USD15 per barrel in a little more than a month.
Fed chairman Jerome Powell this week signalled a faster move to the exit with a statement that it is time to “retire” the word transitory when talking about inflation and said that the Fed can consider ending QE bond buying “a few months” earlier. It’s a clear signal that the Fed is set to increase the pace of tapering asset purchases when they meet in two weeks (15 December). It also paves the way for earlier take-off on rate hikes and we now look for three hikes in 2022 in June, September and December. This is in line with market pricing. We expect another four hikes in 2023, which is 1½ more than the market expects.
The new covid variant Omicron with origin in South Africa added new challenges from the pandemic. The variant has more than 30 mutations, which could leave vaccines less effective and early indications suggest it is more contagious. However, the knowledge is highly uncertain and we need to wait a few weeks to assess it. Europe continues to be the epi-centre and new infections continue to rise. Germany is the latest country to impose new restrictions, see Politico. We expect covid to be a challenge over the winter with some form of restrictions in most European countries. On a positive note, there are tentative signs that bottle necks are easing slightly as freight rates have come down and ships waiting in line outside the port of Los Angeles is down to 17 from 40 just a few weeks ago.
On the data front the euro area delivered the biggest surprise as inflation jumped higher in November to 4.9% y/y from 4.1% y/y (consensus 4.5% y/y). While it was mainly driven by energy prices, core inflation also moved up to 2.6% y/y from 2.3% y/y. However, in contrast to the US, wage growth is still quite subdued and the ECB can afford to be more patient than the Fed. Not least in light of the recent drop in commodity prices. Global activity data did not add much new information. Chinese PMI was still soft and while the US ISM manufacturing was better than expected the US PMI manufacturing was revised lower and painted a picture of weaker momentum.
Over the coming week the main focus will be on news regarding the Omicron variant and US CPI for November. Consensus is for a rise in US core CPI of 0.5% m/m, so another high print is built into expectations. In Europe, we get the German ZEW, which could see a new setback due to covid waves. No changes are expected at the Reserve Bank of Australia meeting and we look for a still dovish narrative from the central bank. At the Polish central bank meeting markets price a 50bp hike adding to a 75bp hike in November.
