Omicron optimism but what about inflation?

The market is starting to come around to the idea that omicron isn’t that bad. At least from a health perspective that is.

The virus strain may be more transmissible but it seems to be less severe than delta. That might be good news in terms of working past fears surrounding the pandemic but that doesn’t tell the whole story.

There might still be the case that hospitals may be overwhelmed in certain parts of the world but the general line of thinking is that as long as vaccinations progress, we’ll get past this eventually. And omicron will prove to be another hiccup in the pandemic episode, just like delta was at the beginning.

However, even if omicron isn’t as deadly/severe, the measures taken up in response are arguably more important. And when we’re talking about this, the big one that matters is China.

At this point, it does not look like the US and Europe will revert back to lockdown measures anymore. They just can’t.

Meanwhile, China is still keeping its ‘zero covid’ policy and the latest headlines from Xi’an only rebuffs that approach.

Keeping that in mind, what is going to happen next as omicron becomes more widespread?

While there is scope for optimism and light at the end of the tunnel, China’s approach will make it tricky to navigate the inflation side of things surely. If we start to see more production shut down and trade ports closed, that will start to rattle supply chains again.

And we already know how that has been playing out amid what has transpired during the pandemic so far.

So, where does that lead us in 2022?

If inflation isn’t quite as “transitory”, we’ll likely be faced with the same debate this year. However, major central banks will have less tolerance in arguing against the narrative and rate hikes are the likely temporary solution.

But that is still very much akin to putting a band-aid on a leaking dam. It’s a quickfix and policymakers themselves know that very well.

So, in the face of prospective rate hikes and potentially rising inflation still, can risk assets keep calm and march on? That will definitely be a major point of contention in the next 12 months.

I’d argue that the ideal scenario (even for policymakers) would be for inflation pressures to stall but it may be wishful thinking to hope for it to return quickly to 2%. But for risk trades, I reckon it’ll be getting over that hump/peak and once that hurdle is cleared, there’s a good chance for a steadfast rally in the bigger picture.

Inflation

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