Omicron and the Economy: Financial Markets Far Less Worried Than Canadian Provinces

by EditorT

U.S. Federal Reserve Board Chairman Jerome Powell in a file photo dated February 11, 2020. The Fed’s December 2021 minutes suggested that Omicron would not derail the U.S. economic recovery. (Photo by MANDEL NGAN/AFP via Getty Images)

U.S. Fed sees rising inflation as a bigger risk; rate hike expectations for BoC remain high

By Rahul Vaidyanath

News Analysis

The difference in reactions to Omicron has been stark between Canada’s provincial governments and governments in other countries. The financial markets have also tended to be far more sanguine as they process the economic and financial implications of the COVID variant.

Some Canadian provinces are reporting that hospitalizations from Omicron are at or near record levels and that their health-care staff are facing a crushing workload. Ontario and Quebec have re-enacted various strict lockdown measures such as curfews and closure of restaurants and gyms.

However, the financial markets quickly recovered from the onset of Omicron in late November. And economists and investors are indicating that they expect central banks to start raising interest rates soon instead of expecting them to provide more stimulus. 

“Financial markets are looking through this [Omicron wave] a bit more optimistically than many governments are in the sense that they think we’re going to get over this fairly quickly and we should go back to normal,” Jean-Paul Lam, an economics professor at the University of Waterloo and a former Bank of Canada assistant chief economist, told The Epoch Times.

Stock markets have given their verdict on Omicron by pushing higher, indicating their belief that the worst of the pandemic is in the rear-view mirror. Their biggest concern has shifted to the risk that the U.S. Federal Reserve will raise rates more aggressively than once thought in order to tame inflation.

In a tweet as early as Nov. 28, American hedge fund manager Bill Ackman already said early signs were that the Omicron variant was more transmissible but less severe, adding that “if this turns out to be true, this is bullish not bearish for markets.” 

Scientists in South Africa, where the first Omicron outbreak was recorded, have suggested that the variant has helped the population build up its natural immunity without killing millions. Thus, they said a decoupling of cases and deaths is likely.

Inflation a Bigger Concern Than Omicron

U.S. headline inflation hit 7 percent for December. And the release of the Fed’s December meeting minutes on Jan. 6 revealed an expectation for reducing monetary policy stimulus sooner than what markets were expecting, given Omicron. 

“Many participants noted that the emergence of the Omicron variant made the economic outlook more uncertain; several remarked that they did not yet see the new variant as fundamentally altering the path of economic recovery in the United States,” according to the minutes of the Dec. 14-15 meeting.

According to a Jan. 11 Deutsche Bank commentary, markets were expecting an 89 percent chance of a Fed rate hike in March, up from 63 percent at the close of Dec. 31 and just 27 percent at the end of November when Omicron had just begun.

A day earlier, Deutsche Bank commented, “the holiday season provided more evidence that Omicron was notably milder, especially amongst the vaccinated, and the result has been that the market has looked through this more than they were willing to before Xmas.” 

Lam points out that the Omicron-related risk to inflation is two-sided. There is a downside risk due to a slowdown in economic activity resulting from government-imposed restrictions, which financial markets think will be temporary. But supply-side issues like labour shortages are worsening and that puts upward pressure on prices.

“I think central banks are trying to balance the two, and for now they’ve taken the view that the latter is more important,” he said.

Lam says financial and economic policy-makers are more worried about rising inflation than they are about Omicron and government measures.

One of the biggest risks to the inflation story is if expectations of higher inflation become entrenched. But according to Moody’s in its Jan. 6 weekly market outlook, longer-term U.S. market-based measures of inflation expectations remained well-anchored. 

“We don’t believe Omicron will be as inflationary as the bond market is betting on,” Moody’s said.

The Bank of Canada’s next interest rate decision is on Jan. 26, and RBC senior economist Josh Nye said Omicron has not affected the markets’ expectations for rate hikes in 2022.

“We look for hawkishness to continue with the BoC’s January meeting likely to signal upcoming rate hikes,” Nye said on Jan. 6.

Temporary Hit

In its U.S. supply-chain stress tracker update on Jan. 10, Oxford Economics said that Omicron threatens to exacerbate supply-chain problems and “risks making it harder for businesses to find workers.” 

However, it added, “We think the variant’s threat will diminish after the first quarter.” 

Canada’s big banks forecast a hit to the economy in the first quarter, but that’s it. 

“This latest wave of COVID-19 is multiples larger than those that preceded it. But the speed of the spread means it’s also expected to run its course more quickly, we expect growth in the economy to bounce back in Q2,” according to a Jan. 7 note from RBC.

BMO is expecting first-quarter GDP growth of just 1.5 percent for the United States and 0 percent growth for Canada.

RBC revised its first-quarter GDP growth for Canada to 1.5 percent, down from 4 percent.

Well down the road, Lam points out that the long-term effects of COVID present a lot of unknowns for the labour force, but that this issue isn’t talked about much due to still scant evidence.

“There are obviously some talks and some evidence emerging that there’s quite a lot of people who suffer from long COVID. And if that’s the case … that will leave some scarring effect on labour and the labour force,” he said.

Canada an Outlier

Ontario imposed widespread restrictions on indoor activities and sent students back home for online learning on Jan. 5.

“I understand the decision to impose new restrictions will disappoint, confuse, and be difficult for some people. If we don’t act now to get this variant under control, the results could be catastrophic,” said Ontario Premier Doug Ford on Jan. 5.

The United States, despite also seeing Omicron cases and hospitalizations soar, has not re-introduced the kinds of restrictions Canada has.

In some states, stadiums are full of fans and there are no mask mandates or vaccine requirements, whereas, for example, the Toronto Raptors are playing with no fans in attendance.

The financial markets would appear to disagree with Ford’s assessment. 

 

Rahul Vaidyanath
JOURNALIST

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