‘Madness,’ The Dollar And An ‘Omnipresent’ Threat

“Madness.”

That’s how one analyst described last week’s post-Thanksgiving price action, which found global equities careening lower with bond yields and crude amid acute concerns over the new COVID variant which, by Monday, had surfaced in nations all over the world.

As the new week dawned, markets were inclined to a more measured approach. “Measured” doesn’t necessarily preclude additional losses, of course. But the panic had subsided. Temporarily, at least. Stocks rose and bonds fell.

“We share the markets’ concern over the emergence of the new variant… but we advise investors against jumping to conclusions based on small data samples and anecdotal reports with potentially large margins of error,” UBS said, adding that while “much has been made of the large number of mutations… their combined impact has yet to be assessed.”

To (re)state the obvious, markets will be hostage to virus headlines for the duration of this week, despite a bevy of top-tier US economic data. Assuming the worst-case doesn’t play out (i.e., assuming no March 2020 re-run) and with the obligatory caveat that what ultimately matters is human suffering and the toll from the virus, what counts for markets is the read-through for the Fed which, as noted here over the weekend, is synonymous with the read-through for the dollar.

Underscoring that on Monday was BNY Mellon’s John Velis. “To the degree the Omicron variant changes Fed pricing, we expect the dollar to follow suit,” he said, noting that Friday’s dip in the previously buoyant greenback coincided with a repricing of Fed expectations. The simple figure (below) illustrates the point.

“These forward prices for the policy rate will dictate dollar direction over the short term,” Velis added.

The corollary is that if Omicron proves to be a “false alarm” (as Goldman nicknamed one of their more benign scenarios for the variant), the dollar will benefit from assumptions around persistent inflation and renewed pricing of preemptive rate hikes for risk management purposes.

“The more markets are convinced that the recovery won’t be derailed, and the inflation spike will persist, the more likely the dollar is to benefit,” SocGen’s Kit Juckes wrote Monday.

“If Omicron doesn’t have a significant economic impact, the case for higher rates is pretty clear,” Juckes went on to say. “For now, that helps the dollar even though it already seems increasingly likely that its peak will come earlier than our current forecast of Q3 2022.”

Elaborating further on Monday, UBS was reluctant to suggest the variant poses a significant risk to the recovery. “Given currently available information, our base case is that Omicron does not warrant a change in our view that the global economy is on a (bumpy) road to full reopening and that growth will be robust,” the bank said.

Fingers crossed. One thing’s for sure: It’ll be interesting to watch the interplay between Fed speak, critical US data and variant headlines over the next several days.

“This week has just become extremely important in gauging investors’ response function to the omnipresent variant risk,” BMO’s Ian Lyngen and Ben Jeffery wrote. “In the absence of this most recent variant, there had been a collective sense of ‘out of the woods’ in terms of the pandemic,” they went on to say. “Alas, the market is once again faced with a reminder of the persistent risk of new variants and the associated implications for the return to the new normal. ”