As the US recovery from the summer Delta wave gathers steam, renewed lockdowns in Europe create downside risks to European growth while geopolitical risks on the European periphery are rising

Idiosyncratic stories drove many of the largest moves in markets last week. Beginning in Turkey where the Turkish Central Bank responded to President Erdogan's desire to “fight against interest rates” by cutting rates by 100bps despite currency weakness and rampant inflation. Unsurprisingly, the Turkish Lira fell sharply, declining by 12.6% over the week, a 5 weekly stdev move, and this sell off has acclerated falling another 14% since Mondays open.

Ukrainian assets declined further, warrants seeing a 2.5 weekly stdev move lower as the Russian troop buildup continued, and there was little sign of conciliation in comments from President Putin. 5y Hungarian interest rates had a 2.4 weekly stdev move higher following a larger than expected 70bp increase of the 1w repo rate (the effective policy rate) by the NBH. EM tech equities declined sharply following poor earnings from sectoral leaders in China and Brazil. Chilean risk premium increased ahead of the Presidential election vote, CDS moving wider by 2.5 weekly stdev.

One consistent thread across many of these moves was an increase in risk premium driven by politics and geopolitics. Politics also played an important role in the nomination process for the next Fed chair. Ultimately President Biden did not concede to the party’s progressive wing and renominated Chairman Powell for a second term. However, with Lael Brainard being nominated as Vice-Chair, this does open up 3 board seats (assuming Clarida leaves) which may be the consolation prize for those who were in Brainard’s camp and may result in a dovish shift in the committee. More broadly, this reduces the risk of a contentious nomination process which would have been a meaningful risk had Brainard been nominated.

While the re-nomination of Chair Powell will have implications over the shape of policy over the medium term, comments on Friday from Gov. Waller and Vice Chair Clarida reflect a much more immediate risk. Both comments clearly signaled that the pace of tapering is a live discussion at the next FOMC meeting. This is in response to higher inflation, with Waller specifically noting “the rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022”. Eurodollar contracts moved higher in yield on Friday having previously been 10bp lower on the day.

Friday’s price action and these comments signal to a larger thematic of increased divergence across markets and regions. US rates had moved lower in yield due to the broadening Delta wave in Europe, which has led to renewed lockdowns, and with it much higher risks to European growth over the coming quarter. EU data was already tepid, dragged down by Germany, which is exposed to both supply chain friction and a slowing China. This is reflected in the solid consensus at the ECB for prolonged monetary accommodation. In contrast, in the US, there is almost no political will for new lockdowns, the economy has rebounded from the summer’s Delta wave, as evidenced by strong retail sales this week, and the Fed is shifting more hawkish. Similarly, in EM, the South African Reserve Bank kicked off their rate hiking cycle with a dovish hike, in contrast with the type of monetary policy actions we have seen in CE3 and Brazil.

We expect this theme of divergence to continue over the next year, especially as we see regional differences in inflation in the context of where central banks are in their cycle. With falling macro correlation, political risks will also play an increasingly important role in relative valuations, and this environment can result in trending moves in currency markets, as we have seen recently in EURUSD. For now, we have reduced our risk, reflecting the rise in idiosyncratic volatility and uncertainty, specifically around Russia’s intent in Ukraine and the growth outlook for Europe. However, on a medium-term horizon, we remain opportunistic as this type of alpha market with political catalysts presents a rich opportunity set for our process.

COVID Pandemic

Global COVID cases continued to advance last week by +10.5% - the fastest weekly increase since early August. Regionally, cases increased in Europe and the US, while falling in Asia, Latin America, and CEEMEA. In China, cases fell by -33.6% over the last week, suggesting recent restrictive measures are again working to keep Chinese cases at low levels. In CEEMEA, the still-elevated COVID waves in Russia and Turkey trended lower over last week. Finally, in Latin America, COVID cases generally remained low across most of the region, with mobility levels in most LatAm countries now largely recovered to pre-COVID levels.

The major COVID news of the week in Europe was the Austrian government’s Friday announcement that Austria will enter a full national lockdown on Monday - the first full lockdown announced in the EU this winter. The Austrian lockdown news comes after a significant surge in Austrian COVID cases, bringing Austrian COVID cases to the highest levels on record. While vaccinations are helping make the winter European wave less deadly than it otherwise would have been, the vaccines have not been enough to avoid sizable winter outbreaks. The below charts shows Austrian cases and deaths and deaths as a share of cases lagged by 20 days which clearly indicates that even when accounting for time lags the current wave in Austria is significantly less deadly. In Germany, where cases hit all-time highs this week, the health minister said “nothing should be ruled out” regarding a national lockdown, while the foreign minister excluded a national general lockdown. In Western Europe, cases continued to rise in Italy, Spain, Portugal, and France.

**Austrian 7d Moving Avg Cases (blue) vs Deaths (orange - lagged)**

US cases also increased meaningfully over the last week, with cases rising +31.2% on the week and test positivity rates also increasing to 6.1%. Leading COVID testing and symptom search data we follow points towards a continuation of the US COVID upswing. COVID wastewater data has also surged recently, as the chart below of Massachusetts COVID wastewater data shows. So far, US mobility levels and surveys on COVID concern have yet to react to the increase in cases, but the risks of a shift to US COVID sentiment and the service sector recovery are growing.

Calvion’s View: As we have been highlighting in recent weeks, near-term COVID risks are elevated despite an increasingly positive longer-term COVID outlook due to the combination of multiple effective vaccines and two antiviral pill treatments. We continue to see rising winter outbreaks in the US and Europe posing a renewed risk to service sector recoveries and consumer sentiment in the regions in the coming weeks. In Europe, we see the recent Austrian lockdown as a clear sign that lockdown policy risk still exists in Europe this winter and must be carefully followed in the coming weeks. In the US, it looks likely that cases will continue to move higher in the coming weeks with risks for consumer behavior and the service sector recovery. Encouragingly, in China, this week’s data suggests the most recent outbreak may be successfully contained. However, we would note that China’s zero-tolerance approach to COVID remains a significant tail risk as long as it is in place and seasonal COVID risks are currently elevated in China.