Analysis of today's markets

Roberto Hernanz, Markets Director at BBVA Private Banking.

Inflation figures and business results are back in the limelight


Although the omicron variant is unlikely to derail the global economic expansion, the latest indicators suggest that growth in the fourth quarter of 2021 and first quarter of 2022 is being affected by the resurgence in COVID infection rates. The activity figures for the euro area, and especially Germany, have been disappointing. Although much of the lost growth will probably be recovered starting in the second quarter of 2022, it is clear that the current situation may require revising the growth rate in the region downward for the year as a whole. Similarly, retail sales and industrial production in the United States in December also reflect a drop in momentum, which should reduce not just the fourth quarter GDP but, as in Europe, it could cause economic growth to be revised downward in 2022.

On the inflation front, the December CPI in the United States exhibited a slightly surprising uptick, similar to that recorded in Europe a week earlier. Thus, the slightly stronger than expected underlying inflation hints at the continuing presence of bottlenecks in supply chains, which are taking longer than expected to be worked out.

On the health front, disturbing news continued to emerge during the week involving COVID cases in China. Although Shaanxi province, the epicenter of the most recent delta outbreak, seems to have controlled the wave after closing its capital of 13 million inhabitants, Henan province experienced an increase in cases and Tianjin, just an hour away from Beijing, reported the first local spread of the omicron variant. The variant's high transmissibility, combined with the authorities' zero tolerance policy, which they are unlikely to relax before the Winter Olympics and the Chinese New Year, could lead to further restrictions in coming weeks. These restrictions imply a downward risk for China's internal demand, but they could also lead to new interruptions in global supply chains, given China's central role in many of them.

To conclude, although sovereign fixed-income markets stabilized last week, the Fed's policy remains one of the main elements of uncertainty we are facing right now. The institution's intention to start reducing the size of its balance sheet, reiterated by Powell in his testimony before the Senate, is the main point of reference for investors, who are concerned that the speed of the adjustment will be higher than in 2017 and 2018, which ended with the collapse of US markets in December 2018. In fact, the potential economic consequences of the so-called quantitative tightening (QT) are far greater than the effects of interest rate changes.

It is also important to note that the process of expanding the central banks' balance sheets was coordinated after the pandemic broke out, while the Fed (and probably the Bank of England) will now carry out its QT by itself. Indeed, the ECB will continue to expand the size of its balance sheet and will stick to the bond purchase program it announced at its December meeting. Only once the program is over, foreseeably in mid-2023, will it hike interest rates for the first time. Although the BCE could reduce its holdings through TLTRO refunds to banks, which could limit their utility starting in mid-2022 in response to less favorable conditions, it will still take years for the ECB to effectively liquidate its bond holdings. In principle, this divergence of policies between the Federal Reserve and most of the rest of the world's central banks could be expected to lead to an appreciation of the dollar, although the recent depreciation of the greenback reminds us of the many factors that influence currencies, making the final effect of QT on the dollar difficult to predict.

Although the stock market did not have as many negative overtones as in previous weeks, the fact remains that the downward trickle continued in the world's leading exchanges. The global MSCI index experienced a slight monthly drop of around 0.15%. In the United States, retail investors refused to be discouraged and once again bought the stock market dips, especially tech stocks, which suffered the most from the Federal Reserve's more aggressive policy. Retail investors pumped over 1 billion dollars into tech companies over the last week, although money also flowed into most of the remaining sectors. In any case, the volatility of the NASDAQ index remained above 25 points for the second week in a row, which had only happened 12% of the time in the previous nine months, reflecting investors' growing concern with technology companies. In fact, at the Friday close, the tech index was 7% below its all-time highs in November.  

In summary, rising energy prices are weighing on the finances of consumers, who are already being affected by new government restrictions intended to contain the omicron variant. According to some published analyses, the energy crisis could reduce the region's GDP by 1% and further add to inflation rates. This week, investors will be watching the final December CPI numbers for the eurozone, which, after growing 5% year-on-year, has been showing the highest levels of inflation since the creation of the euro.

In the United States, the omicron variant is challenging the belief that each wave has a lower negative impact on the economy. With almost 800,000 new cases recorded daily in the country, and with half of the US population expected to be infected by March (similar to the WHO's forecast for Europe), the new variant has forced many people to lock down over a short period of time. This widespread absenteeism has led to company closures and exacerbated labor shortages, while the consumption of services has plummeted.

The data for this week will provide a clearer picture of how omicron has interrupted economic activity. We will see how jobless benefit applications have evolved and see if bottlenecks are intensifying in the regional manufacturing surveys for January.

As for our tactical approach, although uncertainties remain front and center in the short term, we believe that the evolution of the variant in South Africa and the United Kingdom allows us to be optimistic, and we expect the omicron wave to ease in coming weeks. We already saw in the past that economic activity is not lost forever, with much of it recovering at some point. Our favorable health outlook for 2022 as a whole suggests continuing to hold a long position in risk assets.