- Positive start for US and European stock futures, Asia mixed as mood brightens
- But still plenty of caution amid Omicron unknowns and central bank policy shifts
- Busy week lined up – US CPI the highlight; dollar edges higher
Is the Omicron scare over?
After a gruesome two weeks, US equities may be at a turning point as markets digest the growing expectation that the Fed will remove stimulus at a faster pace and amid encouraging signs that the Omicron variant is not as perilous as first feared. Stocks globally got stuck in a selling frenzy after Fed chief, Jerome Powell, indicated he was on board with the idea of accelerated tapering, with the emergence of the Omicron variant and subsequent imposition of travel restrictions further pummelling stocks.
However, whilst the panic over the new Covid strain may now have been overdone, the bond market reaction to the latest virus scare has only underscored the diverging outlook on short- and long-term interest rates. Investors still think the Fed is likely to end its bond purchases much sooner, probably in March, and raise rates in May. The odds for an even earlier liftoff, possibly in March, are also quite high.
Long-term Treasuries defy hawkish Fed
Yet, long-term rates have slid quite sharply over the past two weeks, with the 10-year Treasury yield hitting a more than two-month low of 1.335% on Friday. This has been the silver lining for stocks with bloated valuations that are the most sensitive to increases in long-term borrowing costs as the assumption is that early action on rates will avert the need for steeper hikes in the future.
The biggest risks now are that markets become too complacent again about the virus threat should fears about the Omicron outbreak recede further, or if the Fed turns too hawkish and sets itself on autopilot for a Spring liftoff in spite of the heightened Covid risks.
For the moment, however, this could be another buy the dip opportunity, with S&P 500 futures gaining 0.7% in early European trade and the FTSE 100 and Xetra DAX up a similar amount shortly after their open.
Dollar marches on after strong ISM; China worries persist
In Asia, however, the mood improved only marginally as concerns about China’s economic growth prospects continued to weigh. Evergrande’s never-ending woes and authorities’ ongoing regulatory onslaught on the tech sector are clouding the outlook for the region. Reports that China’s central bank could soon cut the reserve requirement ratio again did little to lift sentiment as investors doubted whether the modest loosening of monetary policy would be enough to kickstart the world’s second largest economy.
In contrast, US economic growth remains robust. Although Friday’s payrolls numbers for November were quite disappointing, the ISM non-manufacturing PMI for the same period hit an all-time high. The employment component also rose while the prices paid index stayed elevated, putting the spotlight on the next CPI report due this Friday.
With the Fed subtly ditching its transitory narrative on inflation, a rate hike in March or May is looking more and more likely and this is helping the US dollar extend last week’s gains even as risk appetite recovers slightly today.
Aussie and loonie climb ahead of central bank decisions
Elsewhere, the euro was struggling, slipping back below $1.13 after the ECB’s Lagarde on Friday reinforced her dovish stance, though the pound managed to recoup some of its losses.
The safe-haven Japanese yen fell across the board and the Swiss franc was another big loser on Monday, while the riskier commodity-linked currencies shined.
The Australian dollar outperformed its peers, boosted by domestic data showing there was a jump in November jobs advertisements – a sign that the labour market is recovering strongly as virus restrictions are eased.
The Canadian dollar was not far behind, firming to around C$1.28 to the greenback after Friday’s massive rise in employment.
Both the Reserve Bank of Australia and Bank of Canada meet this week, on Tuesday and Wednesday, respectively. The RBA meeting likely poses some downside risks for the aussie as the Omicron outbreak gives policymakers an excuse to push back on early rate hike expectations. But the loonie is at risk of a hawkish surprise as the BoC bring forward its rate hike timeline.