ECONOMY

Omicron uncertainty prompts traders to bet on less aggressive Fed policy

Traders are dialling back bets that the Federal Reserve will aggressively tighten monetary policy next year on concerns that the spread of the Omicron coronavirus strain could crimp the US economic recovery.

In just four trading days, market expectations have shifted from three quarter-point Fed rate rises by the end of next year to two, according to fed funds futures, a key tool for wagering on changes in the direction of US monetary policy.

The move in investor expectations, which has also been seen in UK markets, shows how the discovery late last week of the Omicron coronavirus variant has triggered a flare-up of uncertainty over how the pandemic will affect the global economy.

“This is a pretty substantial risk that is clearly forcing some repositioning,” said Jonathan Cohn, head of rates trading strategy at Credit Suisse.

Investors had been adding to bets throughout November that rapid US inflation and the recovery in the labour market from the depths of the Covid-19 crisis would push the Fed to begin significantly reducing its stimulus efforts. The central bank earlier this month announced plans to begin slowing its $120bn-a-month asset purchase programme, but the central bank’s policy rate still stands at a historic low of 0 to 0.25 per cent.

Fed chair Jay Powell added to that sense of uncertainty on Monday when he published remarks saying that rising coronavirus cases and the Omicron variant could pose a threat to the economic recovery and worsen inflation pressures.

Rate rise expectations eased yet further on Tuesday after Moderna chief executive Stéphane Bancel told the Financial Times that he expected existing vaccines would be much less effective at tackling Omicron than earlier strains of coronavirus.

Big trades in Treasury futures earlier this week also showed that investors were unwinding bets against and buying in to US government bonds that had been hit by expectations of a more aggressive Fed stance, said Michael Lorizio, a senior fixed-income trader at Manulife Investment Management.

“There certainly was a one-way push into pricing more hikes over the past month and a half. And this is a fairly sizeable disruption to that,” Cohn added.

The US two-year Treasury yield, a barometer of investor expectations for monetary policy, traded at 0.46 per cent on Tuesday from a high last week of almost 0.7 per cent. Yields move in the opposite direction to prices.

Market expectations of the first UK rate rise have also been pushed back following the emergence of the new variant. Before Friday’s shift, an increase to 0.25 per cent from the current record low of 0.1 per cent was fully priced in for the Bank of England’s December meeting. Now, traders see the odds of lift-off before the end of 2021 at about 50 per cent.

Investors continue to anticipate a series of rate rises next year starting in February and lifting the BoE’s interest rate higher than 1 per cent by the end of 2022, as the central bank seeks to tame inflation that climbed to a 10-year high in October.

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