The race for greater clarity on Omicron

A worrying new strain of COVID-19 has rattled investor confidence, while further complicating the unusually broad spread of paths for inflation and interest rates. But the economic recovery remains resilient.

Light circle

The rapid spread of the new Omicron strain of COVID-19 has further fogged up already unclear forecasts about what winter will bring for households, businesses and monetary policy. After the World Health Organisation (WHO)’s first briefing on the variant, stock markets dropped sharply all around the world and the value of safe haven government bonds jumped. Several countries imposed new travel restrictions and tightened social distancing.

It’s still very early days in the race to know more about Omicron. If it proves markedly more infectious than earlier strains, better able to circumvent vaccines and causes severe illness, many countries may need to rethink pandemic mitigation strategies founded on inoculation. This raises the prospect of more closed borders, more lockdowns and shuttered shops.

Depressing as the prospect of another winter curtailed by COVID restrictions may be, we’ve got very good at living with them. Economies proved very resilient last winter when lockdowns extended for longer than anticipated. Today, businesses and households are still flush with savings. The excess savings amassed in 2020 have not yet, in aggregate, been spent. Businesses have become highly adaptive to remote working and operating under social restrictions. They are probably even more resilient now given continued investment in their systems and gear.

And more shutdowns would be a worst-case scenario. It may turn out that Omicron is less infectious or not as much of a risk to vaccinated people as initially feared. The knee-jerk reaction in markets had a disheartened weariness about it. It has since been followed by a sharp pullback on early reports that the strain results in milder symptoms than first feared.  

The bottom line is that any assessment of this strain and its consequences is highly conjectural. Its discovery simply adds to the unusually broad spread of possible paths for inflation and interest rates that we already face.

Is ‘growthflation’ trumping stagflation?

Even before the WHO announcement on Omicron, investors seemed to be growing more uneasy about the resilience of the economic recovery. In particular, they appeared increasingly worried that central bank efforts to quash rising inflation with higher interest rates might unintentionally choke off growth. November’s disappointing US non-farm payrolls report added another layer of uncertainty to an already fogged-up investment horizon. The US economy added 210,000 new jobs in November, way below the 573,000 expected by economists. But it’s  hard to take a definitive cue from these numbers, which are based on a survey of businesses, because a separate Labour Department survey of households showed strong gains in employment, with 1.1 million more people joining the workforce and the unemployment rate falling to 4.2%, a bigger improvement than those same economists were expecting. While there can be some divergence in the two surveys, it was unusually large this time.

Immediate reactions from bond and equity investors suggested they believe the jobs market is strong enough to keep the Federal Reserve (Fed) on track to start removing some of its pandemic-related emergency stimulus. Yields (which move inversely to prices) on shorter-dated US Treasuries rose in anticipation of the Fed tightening its stance, while 10-year Treasury yields fell. This flattening of the yield curve (when long-dated yields fall relative to shorter-dated yields) implies that investors think growth will slow as a result of the Fed acting now to try to curb an overheating economy.

In terms of the inflation threat, our analysis suggests that some of the supply chain pinch points that have stoked inflationary pressures should start to ease as spending on services relative to goods catches up with more normal trends. Over the long run, spending on services has accounted for three to four times as much of overall GDP as spending on goods, and services inflation has been more muted in this recovery. It’s hard to see spending on goods maintaining its blistering pace, even if social restrictions are further tightened as the new variant spreads. There was good news on this front from America’s latest ISM survey of activity in the services sector – this reached another all-time high at 69.1, significantly above median forecasts of 65.0.

We believe central banks can wait it out on rate rises for now, though admittedly a continuing rise in inflation and a later peak than we previously thought now look likely. We see the overall level of consumer prices starting to ease back down around March or April next year, and there are good reasons to believe that they won’t get out of control. First, inflation expectations remain well anchored: people aren’t rushing out to buy goods because they think their prices will keep going up and up. Secondly, wages would need to rise perpetually to induce the kind of wage-price spiral necessary for inflation to remain high. There’s currently little evidence that this is happening. Indeed, average hourly earnings in the November US payrolls report were unchanged from the previous month at 4.8% per annum.

Meanwhile, leading economic indicators remain strong and consistent with continued momentum in company earnings growth. Yes, these indicators are moderating from their extreme highs as economies initially roared back to life from pandemic-related shutdowns. The post-lockdown rush may be behind us and growth may be moderating, but it’s a very long way from stagnating. Still-robust global growth, together with a strong jobs market and the healthy financial position of both households and businesses, mean we doubt that the current spurt of what’s being dubbed ‘growthflation’ will tip over into stagflation (the nasty combination of economic stagnation and soaraway inflation)

Equity investors can also appeal to history for some comfort. Profit margins nearly always expand during periods of economic growth (with sales going up by more than costs). Since the turn of the last century, profit growth has only failed to beat inflation during the Great Depression of the 1930s and in the 1910s during the First World War.

Finally, geopolitical tensions continue to simmer away. Russia’s military build-up on Ukraine’s borders is the latest potential flashpoint and could gain greater investor attention once a clearer picture of the risks posed by Omicron emerges. The US has warned Russia of strict economic sanctions if it invades its neighbour. These would go much further than those penalties imposed in 2014 when Russia annexed the Crimean Peninsula from Ukraine. These would no doubt centre on oil and gas investment and trade – including the Nord Stream 2 gas pipeline into Germany – something that could quickly exacerbate already heightened energy inflation in Europe.

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Subscribe to the In the KNOW blog email

Archive