According to a recent University of Hong Kong Study1 , the new Omicron variant of Covid-19 infects around 70 times faster than Delta and the original Covid-19 virus. Due to its speed and the newness, it is still too early to conclude its morbidity and mortality toll on an absolute number (rather than % basis to the population) and, ultimately, the economic impact on the U.S. and the world. However, we are witnessing real time delays in returning to offices in 2022, the closing of public venues for entertainment and service impacts on airline travel (shortage of staff due to infection).
Both headline and core inflation (CPI and PCE) have shot up higher in November: 6.8% for CPI, 4.9% for Core CPI and 5.73% for PCE and 4.68% for Core PCE. This is the largest 12-month increase since the period ending June 1982. It does not appear that we have reached peak inflation.
In his testimony on November 30th to Congress, Fed Chair Jay Powell stated that he would retire the use of the word “transitory” when framing current inflation and further acknowledged that the risk of higher inflation has increased.
With the robust recovery since Covid first struck, much criticism has been placed on the Fed for maintaining the 2020 emergency policies of buying securities to foster financial stability and liquidity for far too long which is contributing to inflation. In its December meeting, the Fed announced a more rapid reduction in purchasing U.S. Treasury securities at a rate of $20 billion per month from the November pace of $70 billion monthly and, at the same time, a reduction of mortgage-backed securities purchasing at a rate of $10 billion per month from the November pace of $35 billion monthly. In short, the Fed sped up the winddown of bond buying from the pre-November pace of $120 billion monthly to $0 by March 2022. It is important to note that this tapering should not be deemed tightening but simply less accommodative. The total Fed balance sheet is now at almost $8.8 trillion from a pre-March 2020 crisis level of $4.2 trillion. The Fed now takes the view that inflation may be more persistent and that could place inflation expectations under pressure, and the risk of higher inflation becoming entrenched has increased. The sooner taper ends, the more flexibility for Quantitative Tightening and for the Fed to hike interest rates to further contain inflation.
After a substantially sideways market in the third quarter, the U.S. stock market soldiered on making new highs, albeit with greater market volatility. With inflation continuing to move higher and consumers beginning to feel a pinch in their pocketbooks, the odds have substantially increased that rate hikes are coming in 2022.
The most significant change for 2022 forward is tightening of financial conditions in the U.S. The beginning of similar fiscal and monetary tightening is occurring globally (ex-China) as well. The ECB has begun reducing their Covid emergency bond buying program, while 14 other central banks already raised interest rates since November.
• 2022 is a very different world than 2020-2021.This next post-Covid phase faces uncertainty about scale, speed and timing of Quantitative Tightening and interest rate normalization. 2022 forward reverses the uber accommodation stance and is a reversal of unbridled risk taking. The latest Summary of Economic Projections (SEP) dot plots show three 25bp rate hikes in 2022.