Global stock markets sold off last week as the Omicron Covid virus was first reported and fears around the impact this could have on the global economy were at their highest – which led to increased travel restrictions in many parts of the world. The broad-based US S&P 500 index lost 1.2% last week.
Furthermore, investors last week retreated from highly valued US tech companies which have been quite sensitive to sudden shifts in market sentiment. The US NASDAQ 100, a gauge of the most actively traded stocks on the NASDAQ Composite, ended last week almost 2 per cent lower. Tech stocks, which during the pandemic era have been boosted by coronavirus restrictions, may no longer receive the same support and it could be argued this is an overvalued, expensive sector. However, if it is one thing investors have learnt over the last decade it is ‘buy the dips’.
To compound negative market sentiment, Jay Powell, the Federal Reserve chair, last week signalled his support for a quicker reduction of the central bank’s $120 Billion monthly bond purchases – remember – if the central bank is buying a bond off an investment bank, it is receiving that security but paying the investment bank/primary dealer for the security, so expanding the money supply. Such bond purchases over the last 18 months, have boosted bond prices and therefore reduced bond yields/interest rates thus reducing the cost of borrowing for companies as they can issue new bonds at artificially low interest rates. This central bank bond buying action also boosts equity prices as
- Some of this increased money supply finds its way into the stock market
- Equities become relatively more attractive as an investment opportunity compared to low bond yields.
Furthermore, the Fed’s/Central Bank’s bond purchases, while not directly responsible for the flows into speculative tech stocks and crypto currencies, had created a ‘sense of confidence’ and a feeling that you’ll never lose money!
So, I hope you can see that if the US Federal Reserve reduces its bond buying this can be bad news for financial asset prices. However, if the Central Bank communicates its policy well and in advance, avoiding shock announcements, the markets should take matters in their stride. But ‘normalisation’ of monetary policy is a headwind for markets. The areas that are most speculative and least driven by fundamentals (tech stocks? crypto?) are the most vulnerable.
Core government debt sold off on the Fed news taking the yield on the benchmark 10-year Treasury Bond up 8 basis points (0.08 of 1 pr cent) to 1.42 yield-to-maturity. This key debt yield traded above 1.65% in November before the World Health Organisation declared Omicron to be a ‘variant of concern’. That variant news drove investors to the safety of government bonds.
Commodities: Oil also had a difficult week last week with the international benchmark Brent Crude falling 4% to $70 per barrel with the variant bringing a new risk of slowing the global economic recovery. Gold, like bonds in being seen as a ‘safe haven’ asset, has seen an increase in demand and its price rise over the last couple of weeks from $1.750 per ounce to $1,790.
Looking forward the financial markets will continue to directly react to
- any Omnicron variant news – if investors believe this variant is a real problem, investors will buy bonds and so prices will rise and yields /interest rates will fall. Stocks, although they will like the lower interest rates, they would not like such Omnicron news.
- any news on inflation now running at 4-6% on an annual basis in many developed economies. Central Banks believe this is a temporary supply induced issue related to Covid. Should investors and Central Banks begin to think this is a longer-term problem then that will put an upward pressure on interest rates and downward pressure on bond and stock prices.
- Clearly there could also be a conflict hear. Bad Omnicron news forcing investors to buy bonds and poor inflation news forcing investors to sell bonds. This is the classic and fascinating complexity of financial markets.