Analysis of today's markets

Álvaro Manteca, Director of Investment Strategy at BBVA Private Banking

Volatility grips markets in key week for central banks

12/20/2021

There were no big surprises. The Fed led the aggressive turn by the world's major central banks over the past week, which showed concern about lingering inflationary pressures far exceeding that stemming from the recent surge in COVID infections and the new omicron variant. Thus, the Federal Reserve announced the end of its pandemic support for the economy, doubling the rate at which it will reduce its bond purchases and paving the way for three rate hikes of 25 basis points in 2022. More patient, but also more aggressive than expected, the ECB also announced a gradual reduction of its pandemic programs, as after the end of the PEPP program in March 2022, the institution will buy significantly less, although it will continue to do so throughout the year and probably beyond. Furthermore, the ECB did not show any urgency to raise rates: its inflation forecasts and prospects rule out rate hikes in 2022 and 2023. The big surprise of the week came on Thursday from the Bank of England, which raised its benchmark interest rates, in response to rising inflation and high labor market tensions, making the United Kingdom the first major global economy to raise its rates since the start of the pandemic.

For its part, the Bank of Japan remains on the opposite spectrum and stayed the course, without modifying its monetary policy. At the same time, it announced plans to phase out its emergency financial support program, reducing its corporate debt purchases to pre-pandemic levels, while pledging to take additional relaxation measures, if necessary, amid uncertainty due to omicron.

In another vein, Norway's Norges Bank raised its interest rates by 25 basis points, as expected. It also indicated that it would raise them again in March, while raising its inflation forecast. Switzerland's SNB kept its policy unchanged, as expected, and it is highly unlikely that it will raise rates before the ECB. If necessary, inflationary pressures are more likely to be addressed, allowing for a certain appreciation of the currency.

As for the central banks of emerging countries, Turkey's CBT once again lowered its interest rates by 100 basis points, down to 14%, in line with the consensus, despite the fact that it is by no means ruled out that the inflation rate may reach 30% in the coming months. Furthermore, the Turkish central bank announced a pause in its cycle of monetary easing, after intervening heavily in currency markets over the past two weeks, suggesting that concerns about the volatility of the lira have been very significant. In Latin America, Brazil and Chile maintained their pace of monetary tightening, while Banxico surprised the market with a rise of 50 basis points, joining the pace of Peru and Colombia.

Finally, central banks have removed the term "transitory" from their language when referring to current inflation, admitting the uncertainty regarding its trajectory. In line with the various inflationary pressures that they are experiencing, the Fed and the BoE have opted for stricter measures, while the ECB and the BoJ followed the same direction of tightening, but at a much slower pace. Ultimately, the real evolution of inflation in 2022 will judge whether the ECB can afford to maintain its current accommodative monetary policy or, conversely, whether the more aggressive expectations maintained by the Fed might have to be revised downward if prices are more standardized than expected. At the same time, central banks must assess whether the confidence they showed last week with regard to the current rise in the omicron variant was justified. The PMIs in Europe and the UK were weaker than expected, clearly reflecting the continuing economic impact of a worsening health situation.

The aggressive turn by central banks and the surprisingly rapid emergence of omicron has caused volatility to take over global equity markets. Thus, after the strong recovery of the previous week, in recent days stock market declines dominated and the MSCI world index lost half of the gains of the previous week.

In short, the world will be eagerly awaiting data on the omicron variant of COVID-19, as governments tighten restrictions to contain staggering infection rates. The new variant could have a double adverse economic impact: On the one hand, the new restrictions would dampen activity in the latter part of the year and, on the other hand, supply chain bottlenecks could intensify if Asian countries return to full closures to end outbreaks. In any case, we expect these impacts to be transitory and cannot be expected to distort the constructive macroeconomic scenario that we expect in 2022. Likewise, we would expect greater clarity regarding the infectivity and severity of the variant in the coming days.

As for the European macroeconomic agenda, the flow of data will slow down as the holiday season approaches. In the United States, meanwhile, the week will be much more interesting. In this regard, the Fed's preferred price indicator could show the greatest recovery since 1982. Furthermore, it is likely that real activity indicators will continue to confirm the good performance of the US economy and we expect good data on personal expenses and income in November, as well as on durable goods orders. In another vein, we anticipate greater consumer confidence, thanks to significant wage growth.

As we can see, the two major risks that have been with us in recent months are still very present and both inflation and the health situation will continue to weigh on investors' minds. On the other hand, the aggressive turn of central banks does not seem to have caused a great commotion in the investment community, although we will have to get used to a lower monetary support during 2022.

Despite the existing uncertainties, we consider that the foundations are being laid for continuing to invest in risk assets in our portfolios, since we believe that next year will be characterized by a robust economic performance, which will maintain the growth of corporate profits, while new antiviral treatments will become a powerful ally to finally end the COVID-19 pandemic. Therefore, we say goodbye to the year with the same favorable positioning for risk assets that has been accompanying us since the first weeks of 2021.