This week will shape the macro outlook for the start of 2022, but the key themes of improving global growth and policy divergence are likely to continue
Risk assets head into a critical last trading week of the year after rising sharply over the last 5 days as markets priced lower risks relating to the Omicron variant and received incrementally positive macro news in the form of Chinese policy easing. Ahead of the Fed this week, Friday’s US CPI inflation, came out in line with expectations as the headline rose 6.8% yoy and core rose 4.9% yoy. This was another multi decade record high in inflation and showed broad price increases, however with some signs of easing supply chain pressures and falling gas prices, it may be close to the peak level of inflation in the US.
In macro markets, last week’s moves were consistent with the developments we saw in data and policy. Chinese equities, which have come under significant pressure in H2, had a 2.3 weekly stdev move higher supported by Chinese policy easing. A hawkish tone by the RBA allowed the Australian dollar to outperform in FX, rising by 2.2 weekly stdevs. In EM there was more differentiation, Brazilian 3y interest rates fell sharply and the curve inverted further following a run of weaker than expected data against a backdrop of a hawkish BCB. In contrast, Czech rates rose sharply, following higher than expected core inflation prints as well as hawkish commentary from the CNB.
Since the news of the Omicron variant broke, we have been highlighting that the Omicron variant is likely to bring heightened near-term volatility due to the wide range of potential outcomes. Part of last week's price action can be explained by the market assigning a lower probability to the negative tail outcomes, but we also got some important information about the macro outlook.
First, the Chinese policy mix is becoming incrementally easier. While the 50bp RRR cut and the additional cut of 25bp of the relending rate are not sufficient to turn the tide of weakening Chinese growth, it is a step towards policy easing. Viewed in the context of the focus on “stability” from the Politburo meeting, moderate increase in TSF in November, and steps to prevent additional RMB appreciation, it suggests the outlook for China is improving as we head into next year.
Second, we are seeing increasing divergence in the inflation outlook and policy response functions in EM. In Brazil, long end yields fell sharply following a hawkish BCB alongside lower-than-expected inflation and retail sales. While inflation in Brazil is still high, the outlook for inflation has eased, with Brazilian data clearly showing a material slowdown. The curve has inverted sharply, with the market pricing in cuts in 2022 (as are Czech and Russian curves). These are classic late cycle dynamics and is an environment that is supportive for the BRL, CZK and RUB on a relative basis.
In contrast, the National Bank of Poland placed itself behind the curve again, raising rates by 50bps vs 65bps priced, and talking again about supply side and transitory inflation pressures. Inflation pressures continue to rise in CE3, and while their regional peers in Czechia and Hungary have continued to be aggressive in tightening policy, the NBP has signaled they are reluctant hawks. Real interest rates in Poland are now among the most negative in EM, and the NBP may again need to engage in a series of corrective hikes if their bet on supply side inflation doesn’t pay off.
Holding this policy stance may be made much more difficult at the end of this week, which sees a number of key central bank meetings. Most notably, the FOMC will meet and release its updated statement of economic projections.
The Fed has clearly signaled an increase in the pace of tapering, with the market consensus for an increase in tapering from $15bn to $30bn per month. What may turn out to be more market moving is the dot plot. In September, the median expectation was zero hikes in 2022, although half the committee saw at least one hike. Consensus expectations are now that the median will shift to two hikes for 2022. This itself displays how much more hawkish the Fed has shifted in 3 months, but the range of estimates for 2022, as well as the terminal rate, will also give an updated signal as to how the Powell Fed is considering the policy outlook, given the rise in inflation dynamics and strengthening the economic outlook.
The bottom line is that inflation and the policy response function to that inflation remain the key macro theme. While inflation is broadly a global phenomenon, the heterogeneity in growth outlooks and policy responses underpins our view that we are in an environment that rewards alpha and that this environment can continue for some while longer. Our portfolio reflects this, we remain paid Poland vs received Russia and Brazil, long US homebuilders beta hedged and long Russian ruble in FX, and we have added exposure to European financials, which should benefit from a relatively easier policy stance from the ECB
COVID Pandemic
While there are still significant unknowns about the Omicron variant, the last week has provided additional clarity on several key aspects of the variant. Omicron case growth in South Africa and globally remained elevated, with this week’s data supporting the view that Omicron can likely outcompete the Delta variant in South Africa and globally. The severity trends from the Tshwane District hospital report we highlighted in last week’s note seem to have broadly held up over the last week, with several public health experts expressing cautious optimism about the potential for a lower severity of disease for the variant. While at this early stage, it is unclear how much of the difference in lower severity outcomes is due to Omicron’s intrinsic severity or the levels of immunity in South Africa’s population. Recent data appears to be consistent with either lower severity or some level of immune (natural and/or vaccine-related) protection against severe disease. Relatedly, a preprint released on Thursday found that T-Cells immunity protection from variants will likely hold up against Omicron. However, the last week also brought additional signs of significant erosion of vaccine-related antibody protection, with a recent preprint found a 41x reduction in antibody neutralization against Omicron with the Pfizer vaccine. On Wednesday, Pfizer announced a third dose of its vaccine increases neutralizing antibody titers 25 fold relative to a two-dose treatment.
Globally, COVID cases rose, with cases rising in the United States, while falling in Asia, CEEMEA, Europe, and Latin America. In Asia, COVID cases increased markedly for the week in South Korea where cases rose to the highest levels since the beginning of the pandemic last week. In addition, Chinese cases rose for the week following last week’s notable increase in cases. In the CEEMEA region, cases rose sharply in South Africa, while falling in Russia and Turkey. In Latin America, COVID cases remained low across the region, with the recent increase in Chilean cases fading over the last week.
In Europe, cases fell slightly on the week for the first time since late September, with case declines in many Central and Eastern European countries more than offsetting continued increases in major Western European countries like France and Italy. The decline in cases is already leading to the relaxation of COVID policies in some countries, such as Austria, which is exiting its national lockdown on Sunday following a -61% decline in cases from its November 24th peak. By contrast, case growth continued to rise for the week in the US, although test positivity rates fell modestly. Leading data we track on the US COVID wave, including searches for US COVID tests and symptoms, along with leading wastewater data, points towards a further increase in US COVID cases in the coming weeks.
Calvion’s View: While recent Omicron news has confirmed initial concerns about Omicron’s ability to erode immune protection against infection and infectiousness, recent South African hospital data suggests a worst-case scenario where Omicron is either more severe or able to evade protection against severe disease is unlikely. While we believe the Omicron variant will likely become the dominant variant globally and will drive a renewed wave in global cases, we see the reduction in tail-risks associated with either severity or immune protection against severe disease as a notable positive. With the declines in European cases and the continued rise in leading US COVID data, we see a convergence in relative COVID trends in the winter EU and US COVID waves in the coming weeks.