The Omicron variant has increased uncertainty about the short and medium term macro outlook with a wide a range of potential outcomes depending on the nature of the variant, especially its severity, and the reaction function of policy makers
It has been a volatile fall season in financial markets, and Thanksgiving week took that to extremes. The news of the Omicron variant rocked markets on Friday; front month WTI crude fell 13%, a 4 daily stdev move, airline stocks fell 10-15%, and a full hike was priced out of the front end of the US curve.
Ironically the selloff on Friday followed a run of data which had been quite positive for the macro outlook. PMI data was encouraging, showing that global manufacturing strengthened in November, and there were signs of easing supply chain pressures with delivery times and output prices easing.
In the US, data confirmed a strong rebound in the US economy from the summer Delta wave, inventories jumped 2.2%, real consumer spending rose by 0.7%, initial jobless claims fell to the lowest level since 1969, and we saw a range of upside revisions to US Q4 GDP forecasts. We also received the minutes from the Fed’s November meeting, which, viewed in the context of recent commentary and data releases, supported the view that a faster taper is on the table at the December meeting. This is a supportive picture for continued US equity and USD outperformance, and one where inflationary pressures were likely to continue over the winter.
However, this was before the news of the Omicron variant.
At this point, the way we would characterize our current research on the Omicron variant is that there is cause for concern, but most of the key facts remain unknown at this point. What we, and policy makers, do know is that nature and amount of the mutations of the virus may reduce or at worst eliminate current vaccine efficacy, while also increasing transmissibility. Importantly, we have very little data on the severity of thed Omicron variant.
Over the coming 1-2 weeks, the questions relating to vaccine efficacy will become known, and we will also begin to build a picture of transmissibility and severity. Furthermore, it is probable that as the variant is tested for, more cases will be discovered, which may give a false signal as to the ongoing spread.
As we note in our COVID update, policy responses, so far, have been swift but targeted, focused on travel restrictions and increased testing. In Europe, where lockdowns were already in place, they have been tightened. Some countries such as Israel, Switzerland and Japan have taken a more drastic approach to travel restrictions, but for now there has been little roll back of the reopening of travel on a broad basis.
Put simply, at this moment uncertainty is elevated, and therefore the market has priced in a higher level of risk premium, particularly in assets that would be impacted by travel related lockdowns. This is appropriate, the most politically palatable policy action is international travel restrictions, while increased quarantine and testing requirements will reduce demand for travel.
What is less clear is the political will for renewed broad based lockdowns. Our sense is that it is low, especially in the US, but there is a scenario in Europe where risks associated with the Omicron variant compound the existing Delta wave and seasonal flu season to force more extended and broader based lockdowns. This can occur even without the tail risk of a vaccine resistant strain actualizing. Overall, the risks remain more skewed to the downside in Europe than in the US, and similarly, a rebound is likely to be sharper in US exposed assets. However, if news flow deteriorates and the tail risk increases, this will be a continued correlated move lower in risk assets, occurring at the worst time of the year for liquidity. The tail risk, therefore, is material, which argues for reduced risk and if the opportunity presents itself, fading this move in limited loss formats while uncertainty remains elevated.
COVID Pandemic
The key new COVID development over the last week was the rise of the Omicron variant. As the chart below shows, the Omicron variant has rapidly gained share in South Africa, where the new variant is now driving a new fourth wave. While the number of global Omicron cases still remains relatively small, the rapid spread within South Africa and the large number of mutations (including more than 30 mutations to the spike protein) have raised concerns that Omicron may be more transmissible and escape vaccine immunity. Omicron cases have been identified around the globe, with cases in South Africa, Botswana, the Netherlands, the UK, Hong Kong, Australia, Denmark, Italy, Israel, Belgium, the Czech Republic, and Germany. The global public health community has quickly reacted to this variant, with the WHO naming it a variant of concern on Saturday following an emergency meeting on Friday. National COVID policymakers are also reacting, with many countries introducing targeted travel bans on impacted countries, and Israel even going as far as to ban entry to all foreigners on Saturday night. In response to concerns about potential risks to vaccine efficacy, mRNA vaccine manufacturers Pfizer and Moderna have estimated that they believe that if necessary, they can produce a new Omicron-modified mRNA vaccine that could be available as soon as 100 days to 'early 2022'.
It is worth highlighting that there is still a lot that is unknown about the Omicron variant at this stage, given the limited amount of real-world data on the variant. While there are some initial signs (the speed with which the variant has become dominant in South Africa and mutations that have been associated with high transmissibility), that Omicron may be more transmissible, there are no high-confidence estimates of how transmissible Omicron is at this stage. It is also unclear how much Omicron’s mutations impact natural and vaccine immunity against infection and severe disease, with reliable estimates on the impact on vaccine’s efficacy against severe disease from human trials likely still at least a few weeks away. Finally, severity levels for Omicron remain unknown at this stage, with the potential for the variant to see both lower or higher severity levels (lower severity could be a meaningful positive as the variant may be able to outcompete existing strains but lower overall health risks).
Beyond the Omicron variant, the main COVID developments of the week are summarized below. On Friday, the full trial results of Merck’s Molnupiravir antiviral pill saw efficacy drop from the initially reported 50% to just 30%. COVID cases rose globally in every major region over the last week, with European cases rising to the highest levels since the beginning of the pandemic. High European cases are putting pressure on policymakers to tighten COVID policies in the most impacted countries. While reported cases fell in recent days in the US, this dip appears to be a Thanksgiving holiday-related distortion in the data. Leading data we track, including COVID testing and symptom search measures, and US wastewater data, suggest the US winter COVID wave will resume its upward trajectory in the next week. While US policymakers are less inclined to use restrictive measures than European policymakers, the underlying vulnerability of the US population is greater than in Western European countries, as the below chart from the FT shows.
Calvion's View: The rise of the new Omicron variant adds significant new risks to an already challenging seasonal outlook for COVID risks in Europe and the US. At this stage given the level of uncertainty around transmissibility, vaccine efficacy, and severity the path of potential outcomes from this new Omicron variant risk remains wide. While we see the statements from Pfizer and Moderna that updated mRNA vaccines may be rapidly available as encouraging and suggest a faster response time than the development of the initial vaccines, many EMs are not using the mRNA vaccines from Pfizer and Moderna which have been biased towards higher-income countries. Furthermore, antiviral pills, which are less likely to be impacted by Omicron’s mutations than vaccines (since the antivirals target the virus’s own ability to replicate rather than to attach to human cells), may not be produced in sufficient quantities to provide high levels of protection globally. Pfizer, for instance, has forecast it can produce 50 million doses of its antiviral pill globally in 2022. For context, the world has recorded 177 million reported cases of COVID in 2021 so far. In sum, if the tail-scenarios with the Omicron variant play out, the inter-country vaccine inequality seen in the first half of 2020 risks repeating in 2022 with inequality in the availability of Omicron variant updated mRNA vaccines and antiviral pill availability. In the coming weeks, it will be critical to closely monitor the incoming South African health data, the global spread of the Omicron variant, and estimates on the transmissibility, severity, and vaccine efficacy against the Omicron variant.