Omicron variant and Fed chief deliver one-two punch to stocks

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Global stock prices slumped on Tuesday, as fears about the potentially damaging economic effects of the Omicron coronavirus variant and hawkish comments from the chair of the US central bank swirled through financial markets.

The benchmark S&P 500 index closed the day down 1.9 per cent, erasing gains made on Monday. Since news of the Omicron variant hit markets on Friday, the S&P has fallen by 2.9 per cent. The technology-heavy Nasdaq Composite share gauge was down 1.6 per cent at the bell.

In prepared remarks on Monday Jay Powell, Federal Reserve chair, said rising Covid-19 cases and the Omicron variant “pose downside risks to employment and economic activity and increased uncertainty for inflation”.

The move in markets was amplified on Tuesday by the suggestion from Powell that the US central bank may be open to accelerating its monetary tightening programme to combat inflation.

His comments helped to drive up yields on shorter-dated Treasury securities, which move with interest rate expectations, while driving down longer-dated Treasury yields, which move with economic growth and inflation expectations. The difference between five and 30-year Treasury yields narrowed by the most since March last year.

Line chart of Performance (%) showing US stocks hit by Powell testimony and Omicron fears

The two-year Treasury yield, which is particularly sensitive to interest rate expectations, rose 0.07 percentage points to 0.55 per cent.

Earlier, Europe’s Stoxx 600 index closed down 0.9 per cent lower, following a choppy day of trading marked by worries about the new variant’s potential to evade vaccines. Hong Kong’s Hang Seng index and Tokyo’s Nikkei 225 both lost 1.6 per cent.

Stéphane Bancel, chief executive of the US vaccine maker Moderna, predicted in an interview with the Financial Times that existing jabs would be much less effective at tackling Omicron than earlier strains of coronavirus. He also warned that pharmaceutical companies would take months to manufacture new variant-specific vaccines at scale.

Crude oil prices dropped as the vaccine doubts sparked renewed concerns about a slowdown in global mobility and a hit to the recovery in oil demand. Brent, the international marker, settled 3.9 per cent lower at $70.57 a barrel, its worst month since March 2020. The price of West Texas Intermediate, the US oil benchmark, settled at $66.18, down 5.4 per cent on the day, having earlier hit its lowest intraday price since August.

Line chart of  showing Omicron variant knocks oil price

“The looming shadow of the Omicron Covid-19 variant is growing darker over global oil markets today, following concerning news regarding vaccine effectiveness from the CEO of Moderna,” said Louise Dickson, senior oil markets analyst at the consultancy Rystad Energy, referring to the FT article.

“The threat to oil demand is genuine,” said Dickson, suggesting that another wave of lockdowns could result in the loss of 3m barrels a day of demand, or about 3 per cent of the global total, in the first quarter of next year. She cited “tell-tale evidence” of a tightening of restrictions in countries such as Australia and Japan.

Oil market attention is now on the Opec+ meetings this week, where the producer group will decide whether to pause its plans to increase supply in the coming months in order to prop up an increasingly bearish market.

Investors expect markets to remain volatile as information emerges about Omicron and the capacity of governments and existing vaccines to contain it. Wall Street’s Vix index, a measure of expected stock market volatility, rose to 27 on Tuesday from 23 in the previous session — higher than its long-run average of 20.

Although the US has not detected any Omicron cases so far, President Joe Biden has predicted it will emerge in the country.

“The magnitude of market reactions may still increase if we start seeing cases of this variant in the US,” said Tancredi Cordero, founder and chief executive of the investment advisory boutique Kuros Associates.

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