Your weekly economic update from the team at FXD Capital
With the markets digesting the effects of the Omicron variant with erratic swings on an intra-day basis, one day, the crash of all crashes is coming and then the next, everything goes back to all-time highs. However, the main drivers of events are switching from central bank HQs to the realms of geopolitics. Omicron aside, an escalation of tensions at the Russia-Ukraine border and the canary in the coal mine of China’s Evergrande property conglomerate on the precipice, such effects may portend what is in store for the next quarter.
From the Ukraine perspective, aside from the potential of Europe’s first “official” armed conflict event since the 90s, the issue is also particularly destabilising for energy prices, which naturally cause a butterfly effect elsewhere. Ukraine’s risk is buttressed by its position in the middle of gas pipelines from Russia to Europe; if/when the new Nord Stream 2 pipeline comes online, that position disappears. The fear is that at that moment, Ukraine may become vulnerable. While the risk of conflict is the primary concern, any escalation of events will have huge ramifications in markets. Upon an event, the situation will severely complicate yield markets – as government bonds will have the action/reaction effect of the prevailing rise in rates (from inflation concerns) countered by contraction in credit spreads of safe harbour issuers.
Over to China and Thursday’s confirmation that Fitch declared Evergrande as in “restricted default” added another chapter to its long saga. With $300bn of total liabilities ($19bn in international markets), the effects of any action as a result of the technicality will be bruising locally and abroad. The group is resisting selling its best assets and appears to be banking on government bailouts, the stakes of which for the state are high, considering the number of homebuyers who have fronted Evergrande cash. With another developer, Kaisa, in the crosshairs for default, setting a precedent now with Evergrande may not close the door and instead invite a wave of events hoping for safe harbour.
Away from regulated markets, the correlation of cryptocurrency falls with corresponding stock market falls last week was seen as a cause celebre in some ranks. While the informal view is of crypto as a “save haven” in some regards, prices falling with stocks signal a growing linkage of institutional asset behaviours, with the risk on/off taps causing uniform shifts into prime government bonds. For crypto to fall (peak of -20%) on the Omicron data is a sign that less idiosyncratic trading is taking place in such markets, and behaviour is starting to follow the norms of market fundamentals.
While up to now, any COVID escalations have generally been followed by falls in assets like travel and rises in growth/work-from-home assets, the current situation is turning. Before, the view would be that more lockdowns = more stimulus and cans kicked down the road, now a different perspective is being followed. Sentiment now is that more lockdowns will be inflationary due to the stimulus necessary and the further muddying of waters for clearing up logistical blocks. This week, the ECB noted such thoughts when it reassessed its commitment to extra stimulus measures due to doubts about inflation’s reversion to the (expected) mean in light of new lockdowns and incidents. Eurozone inflation hit 4.9% in November, and recent hard-ish lockdowns in Austria and the Netherlands have resulted in the ECB revising whether to turn the stimuli taps down further not to exacerbate further inflationary pressure seeping into 2022. The ECB’s €1.85 trillion bond purchase scheme is expected to end next March, but that decision is now up in the air.
Later on Friday, economists expect the latest US consumer price data to show a 6.8% increase in November. Sobering figures, if they do indeed come to light.
All the best for the week ahead
Alex
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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