Omicron restrictions and stimulus withdrawal haunt markets
Global stocks, crude oil, and riskier currencies take a sharp hit
Dollar shines amid flight to safety, Turkish lira capitulates
Global markets are taking fire from multiple directions as the new week gets underway. With Omicron spreading like wildfire through Europe, countries like the Netherlands have gone back into full lockdown while Germany and the UK are considering new measures that could hamper economic growth.
The playbook throughout the pandemic has been that financial markets can absorb restrictions without even a scratch. However, the twist is that policymakers can’t ride to the rescue this time. Central banks have their hands tied by roaring inflation while most governments have lost the appetite for enormous spending packages now that debt levels have ballooned.
President Biden’s $2 trillion economic agenda is dead in the water after Senator Manchin said he won’t support it after all, while senior Fed officials are openly warning that interest rates could be raised by March if needed. This hawkish remark by Fed Board Governor Waller caused the yield curve to flatten further, signaling that bond traders are becoming increasingly concerned about a recession.
In other words, the underlying forces behind the ‘buy any dip’ mentality are slowly fading away, even if many traders are still conditioned to it. Volatility episodes could become a more frequent theme next year as some liquidity is withdrawn and markets learn to drive without support wheels.
Stocks and commodity currencies get hit
With a sword hanging over the outlook for economic growth and little prospect of more stimulus to counter the slowdown, risk aversion is the name of the game on Monday. Stock markets across the world are submerged in a sea of red, while crude oil prices and riskier currencies have suffered serious injuries.
Thin liquidity conditions are likely amplifying these moves as many big players have closed their books for the year already, leaving the market emptier and hence more vulnerable to sharp swings.
Many charts are now flirting with crucial support levels. The S&P 500 is approaching its 100-day moving average, a barrier that has acted like a trampoline for the index in the past. Meanwhile, Cable has erased all the gains it posted after the Bank of England raised rates and is now threatening a breakout.
Dollar and yen shine, Turkish lira implodes
The US dollar and the Japanese yen have been the biggest beneficiaries of the flight to safety, which was also reflected in the bond market as traders loaded up on defensive assets. There isn’t much on the economic calendar this week, so any news around the spread of Omicron will likely remain front and center in driving sentiment.
Elsewhere, the Turkish lira has been smashed to smithereens after President Erdogan repeated that markets shouldn’t expect anything other than rate cuts from the central bank. The pace of depreciation in the lira is truly staggering, with the currency losing more than 40% of its value against the US dollar over the last two months alone.
With FX reserves depleted and rate increases out of the question, it seems like a matter of time until either capital controls are imposed or currency depreciation feeds into political instability. It is impossible to say where the bottom is for the lira, but when a sell-off is so stretched, even the smallest hint of a change in the landscape can ignite a massive rebound.