• Last quarter, we anticipated the birth of a new variant that requires yet to be developed vaccines to protect against.  Unfortunately, the new mutated variant, Omicron, has proven to be significantly transmittable with many breakthrough cases for those previously vaccinated.  Even though the resulting mortality rate has been low (a great sign), the already overtaxed health system and professionals are increasingly unable to care for the onslaught of patients. Furthermore, the long-term impacts of Covid on the infected remain unknown.
  • Omicron is a global threat and has material economic impact. According to the World Health Organization, the Omicron variant has been reported in 89 countries as of December 18 and the number of cases is doubling in 1.5 to 3 days in areas with community spreading. The zero-Covid policy in China continues to challenge China’s employment and economy and the global supply chain. To make the challenge worse is a recent study that suggests the ineffectiveness of the Chinese vaccine, Sinovac.  Although zero-Covid policy seems draconian, without it and without prevalent access to a robust vaccine, China cannot afford to freely open its economy now. Nonetheless this policy cannot be a sustained solution for China.
  • The base case for inflation is to peak in the first 4-months of 2021 and for inflation forces to wane over an extended tail period. The global supply chain is not yet back to normal, and Omicron is slowing the normalization process. The general focus from just-in-time manufacturing to just-in-case and from offshoring to near-shoring have cost considerations. The pivot to resilience from pure efficiency also adds weight to inflation. The longer the pandemic persists, the longer it will take for the global supply chain to normalize. In the meantime, demand for goods remains elevated as the service economy continues to face uncertainties due to waves of Covid infections. The Great Resignation added to labor shortage further hindered the service sector’s attempt to return to normal. One concern is that, when Covid variants subside and consumers shift from the goods to service sector, it may further challenge strained service resources which can cause inflation to shift to the service sector in terms of even higher wages, thereby extending the higher inflation regime for a bit longer.
  • On the other hand, the end of fiscal stimulus or fiscal transfer and the beginning of a less accommodative monetary policy globally are likely to elicit a gradual tightening of wallets among consumers. This will naturally lower demand and dampen inflation. This could also make U.S. dollar denominated assets more attractive and drive up the U.S. currency against trading partners (those that have not taken countermeasures) and further push down inflation.  However, if not timely managed (rate actions too early, too late, or too much), policy mistakes could cause risk aversion, resulting in stocks and other risk assets to tumble, resulting in financial instability.
  • It is widely accepted that peak growth for the U.S. during the current cycle has passed. Excess tightening may hasten growth slowdown in the U.S. to below the projected 4% this year.
  • The most obvious risk in 2022 is the Fed’s normalization process.  The uncertainties from inflation, economic growth, and policy response set up a challenging environment for the stock and bond market, not to mention impacts from possible new Covid waves to come.

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