INSIGHT: Omicron variant, Fed’s hawkish tilt point to slower US and global economic growth

Joseph Chang

30-Nov-2021

NEW YORK (ICIS)–The emergence of the Omicron variant and the US Federal Reserve’s new hawkish tilt point to slower US and global economic growth going forward, putting pressure on the outlook for economically sensitive sectors such as chemicals.

While much is still uncertain about the potential impact of Omicron, it is clear that it will limit human mobility and further disrupt supply chains, just when constraints were starting to loosen somewhat.

The crude oil market gave its verdict on the impact to mobility. Prices plunged on 30 November, with Brent down 3.9% to around $71/bbl, and US WTI declining 4.6% to about $66/bbl.

Moderna CEO Stephane Bancel told the Financial Times he expects a “material drop” in the effectiveness of current vaccines against the heavily mutated Omicron variant, and that it could take several months to produce an Omicron-targeted vaccine at scale.

It is not just about travel restrictions and perhaps less traffic to restaurants, department stores and entertainment venues, but the impact on labour if more people avoid working in-person or are restricted from doing so.

Shortages in labour – take in trucking for example – have been a critical component to logistics and supply chain constraints, ultimately contributing to higher inflation.

Inflation, which is already running hot in the US and worldwide, and the Fed’s response to it, is key to the economic outlook.

The US Consumer Price Index (CPI) for October was up a stunning 6.2% year on year – the most in more than 30 years. Excluding food and energy, the core CPI was up 4.6% year on year – still at elevated levels no matter how you slice it.

Inflation is a global phenomenon as well. Eurozone inflation has just come in at +4.9% year on year in November – a record high and well above the European Central Bank’s 2% target.

FED SHIFTS FOCUS TO INFLATION
The US Fed is now preparing to take away the monetary punch bowl fueling inflation.

“The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labour market and intensify supply chain disruptions,” said US Fed chair Jerome Powell, in his testimony to Congress.

While pointing out that forecasters, including at the Fed, continue to expect inflation will decline significantly over the next year, “it now appears that factors pushing inflation upward will linger well into next year”, he added, pointing to supply constraints in particular.

“Price increases have spread much more broadly in the recent few months across the economy, and I think the risk of higher inflation has increased,” said Powell, who now sees elevated inflation through mid-2022.

LESS SLACK IN LABOUR MARKET
The Fed chair also noted that slack in the labour market is diminishing, with wages rising at a “brisk pace”.

“I don’t think there is much slack in the labour market. New unemployment claims were back to 1969 levels and the JOLTS (Job Openings and Labor Turnover) report shows 1.3 openings for every unemployed person. And because of the skills/knowledge mismatch, the actual labour shortage is much worse,” said ICIS senior economist Kevin Swift.

“The Great Retirement of baby boomers, mothers and others has affected labour force participation,” he added.

This focus on inflation is a big shift from the Fed’s prior view on inflation as transitory, and its focus on supporting the economy through the ongoing pandemic and maximising employment.

In fact, Fed chair Powell said it is time to retire the use of “transitory” in describing inflation.

TAPER POISED TO ACCELERATE
In response, the Fed will discuss accelerating its tapering of asset purchases – Treasurys and mortgage backed securities (MBS) – at its December meeting. This month, the Fed began tapering its $120bn in monthly asset purchases to the tune of $15bn/month, as was the plan going forward.

Tapering is now poised to accelerate, opening the door for interest rate hikes faster than anticipated.

“At this point, the economy is very strong and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases… perhaps a few months sooner,” said Powell.

Up until the December meeting, the Fed will also take into consideration another inflation and labour report, along with greater clarity on the Omicron variant, he noted.

Much remains unknown about Omicron, and the markets are likely to swing wildly from headline to headline until clarity emerges.

“If it is like Delta, it may slow US economic activity, like during the summer with a few state and local soft lockdowns… [with] a few soft months in food service, leisure and hospitality and travel,” said Swift from ICIS.

“Manufacturing outside of few labour-intensive industries such as meatpacking likely won’t be affected. I think most firms have adapted and are ready for something like this,” he added.

Credit ratings agency Fitch Ratings points out that it is too soon to incorporate the impact of Omicron into its economic growth forecasts until more is known about its transmissibility and severity.

“We currently believe that another large, synchronised global downturn, such as that seen in H1 2020, is highly unlikely but the rise in inflation will complicate macroeconomic responses if the new variant takes hold,” said Fitch Ratings in a report.

While a repeat of the recession in H1 2020 is unlikely, “the return to pre-pandemic levels of activity in the most exposed sectors, such as tourism and international travel, will be disrupted, and the shift back to services from goods consumption may also slow”, according to Fitch Ratings.

MORE VOLATILITY AHEAD
In the meantime, prospects of an accelerated Fed tapering and an earlier interest rate hike will inject further volatility into commodity and financial markets.

US equities took another hit on Tuesday 30 November after a recovery on Monday from the mini-crash on Friday 27 November. However, it is worth noting that Monday’s stock market rebound was centered around technology and left out cyclical sectors such as chemicals.

Chemicals stocks did not bounce on Monday with the rest of the market and saw further declines on Tuesday 30 November.

“Not too long ago, many were likely feeling that the world was just turning the corner on getting back to normalcy, but the reports of the Omicron variant have pushed the market to go haywire,” said Frank Mitsch, analyst at Fermium Research, who noted “there is room for heightened volatility”.

Themes for chemicals in 2022 include raw material inflation exacerbated by supply chain issues, he noted.

“Furthermore, it’s likely that the chips shortage issues will bleed into at least H1 2022, impacting such auto-exposed companies as Axalta, Celanese, DuPont and PPG,” said Mitsch.

“Also, companies with greater Asian exposure are having to navigate the near-term impacts related to Chinese dual control/clear skies regulations,” he added.

The analyst is positive on chlor-alkali producers Olin and Westlake, and titanium dioxide (TiO2) producers Tronox, Kronos and Chemours for 2022, and less optimistic on olefins and polyolefins exposed names such as Dow and LyondellBasell.

“There’s no denying that the concerns of [olefins and polyolefins] oversupply and margin pressures were elongated through the last 18 months given production issues, but supply is set to come online, and with it, the elevated margins of 2021 will likely dissipate,” said Mitsch.

Insight article by Joseph Chang

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