Omicron selloff looks overstretched

Last Friday could be designated as 2021’s worst day in financial markets. Risk-off sent global stocks, oil prices, commodity currencies, and Treasury yields sharply lower, reminding investors of the dark days in early 2020. The Greek letter, “omicron” has suddenly changed the game in markets and has quickly risen to the top of investors’ concerns. The WHO introduced this term and has designated the latest Covid variant as a ”variant of concern”.

When investors are introduced to a new risk factor, the initial reaction is to sell first and ask questions later. Lower market liquidity after the Thanksgiving holiday also exaggerated the selloff as the Dow Jones Industrial Average fell 905 points and the volatility index “VIX” spiked more than 50%. Following a two-day weekend, traders and investors are trying to digest the latest developments, and the recovery this morning in risk assets indicates markets went too far. Still, we’re not entirely out of the woods.

So, what do we know about the new Covid variant? Preliminary evidence suggests an increased risk of reinfection with this variant, meaning that it could hasten a new phase in the pandemic as we enter the winter season. Travel restrictions are already implemented in many countries and new lockdowns should not be ruled out.

According to South African Doctors, patients with the Omicron variant had very mild symptoms which could be treated at home. However, most infected patients were young and healthy and we do not know the impact on the elderly or people more at risk. With over 30 mutations, the new COVID-19 variant might elude currently available vaccines, but we do not know that for sure as it takes weeks to run scientific studies.

There are more questions than answers at this stage; it could turn out to be better or worse, depending on new findings. But investors today decided to downplay the worst-case scenarios and buy the dips. Also helping traders put risk back on is the diminishing expectation for US monetary policymakers to tighten policy. Interest rates futures are now indicating that the first US rate hike will occur in July compared to June, as of earlier last week. Now markets expect only two rate hikes for 2022, down from three before the Omicron news. However, these expectations could change dramatically over the coming weeks as we get to know more about the new variant.

Overall, investors need to be prepared for heightened volatility as markets respond to day-by-day headlines. Following weeks of tranquil markets, get ready for some big moves as we move into the last month of the year.