Omicron distracts and disrupts
Data released in the first few weeks of 2022 paint a hazy picture of the economy, showing the impact of the odd omicron outbreak on activity and dynamics in many parts of the world.
Chinese Q4 GDP growth was just 4.0% year-on-year, confirming the slowdown seen in the second half of 2021. Strict regulations, turmoil in the real estate sector and strict lockdown weighed on activity in December. This trend may continue into early 2022.
There was also no bright spark from the latest US retail sales numbers: December sales were down 1.9% from previously revised November figures. Domestic concerns and pandemic restrictions were behind the biggest drop in sales in 10 months. Anticipated purchases in October, as consumers worried about shortages, likely contributed to the slowdown in November and December.
Taking a longer perspective, December sales grew by 19% in February 2020 – before the pandemic – and up 13% in December 2020.
Rising household income against a backdrop of solid job creation and rising wages argues for spending well in the coming months, but high inflation will cripple households’ purchasing power and control retail sales.
The results of the first US Regional Manufacturing Survey (conducted by the Federal Reserve Bank of New York) showed a sharp drop in activity. The Empire State Index fell 33 points to slightly below zero as orders fell sharply.
Is this the start of a worrying trend?
We do not believe so. From an economic perspective, domestic demand, supported by continued gains in employment, appears solid enough to pick up again once the dust settles. Even though we have revised our GDP growth forecast by 0.3 percentage points for the US and 0.2 ppt for the Eurozone, our medium-term outlook remains intact. GDP growth this year should be well above the long-term average for G10 economies.
In China, where the slowdown is deeply rooted, officials have decided to renew support for the economy. On January 17, the People’s Bank of China cut its medium-term loan facility rate for the first time since April 2020; It was earlier than expected and deeper than expected. Further policy easing steps are likely to follow.
The effect of the Omicron wave on growth should begin to subside. The outbreak has started to subside and has caused far fewer hospitalizations and deaths than previous types. Several governments are considering lifting restrictions, which were initially less stringent in many cases. It appears that vaccination has become a priority.
It is thus expected that this type is the first manifestation of an endemic disease. Confirmation will prove to be a boon for the markets. Of course, the pandemic has already become less of a focus for investors.
Why are stocks falling?
Global equities began to decline on January 5 when the minutes of the December meeting of US monetary policy makers confirmed the less indifferent stance of the US Federal Reserve. Between January 4 and 19, the MSCI AC World Index (in US dollar terms) fell 4.0% to its lowest point since December 20.
However, for us, this fall doesn’t have the characteristics of a broad dedication. It has been very selective. At the end of January 19, the S&P 500 index was down 4.9% from the end of 2021, while the tech-heavy Nasdaq Composite fell from 9.1% to the lowest level since early October (see Exhibit 1).
The 35bp rise in US 10-year yields hit growth stock indices hard – this market segment is particularly vulnerable to high discount rates.
One theme has dominated the markets since the start of the year: expectations of the Fed raising policy rates soon and driving up its asset-heavy balance sheet in the face of rising inflation.
Clearly, investors believe the latest — softer — economic data will not deter the Fed and other major central banks from their tight post-pandemic roadmaps.
The Fed’s policy meeting on January 25 and 26 should allow it to confirm that the first hike in its key rates will take place in March, as anticipated by current fed funds futures levels. It looks like the media briefing will be largely devoted to the question of balance sheet, that is, opening up of pandemic-era asset purchases.
2022: Keeping pace with the changing tune
We expect the market to re-focus on fundamentals. This can already be seen in diversified returns for equity (see above) and credit. Thus, the start of the corporate earnings reporting season will be watched especially closely for clues.
In addition, investors will adapt to the changing monetary policies. There is scope for normalcy now that the economic environment is conducive. However, change is a source of stress and the road can be bumpy. There will certainly be opportunities for investors, but it is also important that asset allocation choices are made taking into account the risk of a more brutal rise in interest rates.
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