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Investors spooked by omicron strain, Federal Reserve conceding inflation

The emergence of the new coronavirus omicron strain in the United States, as well as the central bank’s reluctant admission that inflation may be longer-term, has roused the bears over the last week.

MANHATTAN (CN) — Markets tanked this week as concerns grow over the new omicron strain of Covid-19 and the imminence of the Federal Reserve pulling the plug on its support due to persistent inflation concerns.

While neither storyline is terribly surprising — the Fed has signaled for months that it would soon begin the process known as tapering, even if it has remained steadfast in the new that inflation was merely transitory, and markets already were contending with the virulent delta strain — investors panicked.

For the week, the Dow Jones Industrial Average lost 320 points, while the S&P 500 and Nasdaq fell 56 and 406 points, respectively. But coupled with the losses on Black Friday, the indices have shed more than double or even triple those amounts.

“Although news events over the past few days weren’t shocking by any stretch, reactions indicate the fragility and volatility of a fully valued market with more questions than answers in the near term,” James Vogt of Tower Bridge Advisors wrote in a Friday investor’s note. “The good news is acceleration in market volatility like we saw earlier this week is typical at the end of a correction.”

The carnage began the day after Thanksgiving, with the Dow falling roughly 1,000 points, and the S&P 500 and Nasdaq seeing similar declines. Markets would fall again on Tuesday and Wednesday — the Dow logged losses of 651 points and 461 points, respectively, during those days — only to recover some of those losses on Thursday.

One of the factors causing investors jitters is the Federal Reserve becoming quickly more hawkish on both its bond-buying programs and its approach to interest rates.

“The recent rise in Covid-19 cases and emergence of the omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation,” Fed Chair Jerome Powell told the Senate Banking Committee earlier in the week.

Powell later clarified that “it’s probably a good time to retire” the phrase “transitory inflation” and that he believes inflation will not be temporary but instead will not leave “a permanent mark” on the economy.

The Fed, which is scheduled to soon being tapering its $120 billion-per-month asset-purchase program is also now discussing accelerating the speed at which it stops buying Treasuries and mortgage-backed securities. Other Federal Reserve officials, including the president of the Cleveland Federal Reserve, have said they want the central bank to taper faster.

“Powell just added gasoline to the fire by finally admitting that inflation isn’t going away as fast as anyone would like,” said Ryan Detrick, chief market strategist for LPL Financial after Powell’s comments. “A faster tapering is probably coming as a result and that has markets worried the punch bowl is leaving the party.”

Charlies Ripley, senior investment strategist for Allianz Investment Management, agreed that investors should expect market volatility throughout the first quarter of 2022, noting that is when the Fed could end its bond-buying program.

Additional mixed news hit investors on Friday in the form of the U.S. Bureau of Labor Statistics’ monthly jobs report. According to the agency, the work force grew by only 210,000 jobs in November, but the number of unemployed fell by 542,000 to 6.9 million in total. The previous two months’ jobs reports had been revised upward by 82,000 jobs, but there is no doubt that November’s numbers are still a disappointment.

Chris Zaccarelli, chief investment officer for the Independent Advisor Alliance, called the report “a big miss” compared with the 550,000 jobs most had expected. Even despite the numbers, however, he noted that the report shows a “robust labor market” since the labor force participation rate increased while headline unemployment dropped to 4.2%.

“Given rate hikes on the horizon and a tightening of financial conditions, some caution is warranted, but if the economy continues to expand and inflation can be kept under control — two big necessary conditions — ultimately this will be good for the stock market and bad for the bond market,” Zaccarelli said.

Some sectors did better than others. The transportation and warehousing industry saw a 50,000-job boost last month and is actually 210,000 higher than the February 2020 level, the month before Covid lockdowns took hold. Construction and manufacturing also added jobs. But retail jobs once again dipped — this time by 20,000 jobs, though some experts peg that on Black Friday shoppers becoming more accustomed to buying online.

Two other bright spots were the report’s household survey data, which show an overall 1.13 million job gain from October to November, and the percentage of Americans leaving their current jobs for something better gained a percentage point, from 11.5% to 12.5%, also the most since February 2020.

“Bottom line, while the headline number disappointed relative to expectations, the big household survey figure, the rise in the work week, the increase in the participation rate and employment-to-population ratio, along with the near 5% average weekly earnings print, all point to a Fed that will quicken the pace of taper as many have said,” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Services.

Earlier in the week, jobs data from ADP reflected a 534,000 increase in private sector employment, with large businesses taking half of the pie and small- and mid-sized companies splitting the remainder. Service-producing sectors saw the biggest increase in jobs, according to ADP, at 424,000, while manufacturing, mining and construction saw a 110,000-job gain.

While 15 million jobs have been gained since the economic recovery began, the overall picture is still 5 million jobs shy of pre-Covid levels. “The labor market recovery continued to power through its challenges last month,” said ADP Chief Economist Nela Richardson in a statement. “It’s too early to tell if the omicron variant could potentially slow the jobs recovery in coming months.”

It’s certainly hard to blame lukewarm jobs data on the recent outbreak of the omicron variant in the United States, since those cases were not apparent in November, but many experts say the general uptick in Covid-19 cases played a part.

Gregory Daco of Oxford Economics predicts the variant will cause moderate economic damage, mostly confined to the first quarter of next year, with investors “playing catch up” in the spring and summer. “While the World Health Organization deems omicron a ‘variant of concern,’ it would be premature to assume a major U.S. economic correction will ensue,” he wrote in an investor’s note.

Daco is cognizant, however, of the possibility that the new variant is vaccine-resistant and extremely contagious, leading to a surge in hospitalizations and deaths. “In such a scenario, virus fear reemerges as a key constraint on economic activity and authorities reimpose strict restrictions,” he warned, adding that in such a case gross domestic product likely would gain less than 2% next year.

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