Omicron coronavirus variant shows just how fragile global recovery can be

▶ There will always be the risk of a new variant without broader, worldwide vaccine cover

Even before the South African scientists announced last week that they had identified a new Covid-19 variant of concern, coronavirus infections were on the rise in Europe, the UK and in parts of the US.

Several European countries have imposed new restrictions, with Austria going into a national lockdown for up to three weeks. Economists are already revising down their estimates for the fourth-quarter gross domestic product growth in the eurozone on the back of the impact these restrictions would have on economic activity.

The outlook for the US, though, is more encouraging, even with a rise in coronavirus infections there. Vaccine mandates are expected to boost inoculation rates, although court challenges mean these apply only to federal government workers for the time being. Consumer spending remains strong and the labour market is showing sharp improvement.

The summer’s weak employment gains were revised higher and employment increased by more than forecast in October. Initial jobless claims fell to a 52-year low in the week to November 20 and – provided the momentum is sustained – the US economy looks to be on track to reach full employment around the middle of next year.

This would allow the Federal Reserve to shift its focus squarely to inflation, which has continued to surprise on the upside.

While the central bank and most economists continue to expect inflation to slow next year, it will probably remain well above the Fed’s goal of 2 per cent on average.

Several Fed presidents have already raised the possibility of accelerating the rate at which the Fed tapers its asset purchases as inflation concerns mount. And before the Thanksgiving holiday, the market had priced in one interest rate rise by June 2022 and a further two increases before the end of next year.

Then came the announcement last Thursday of a new variant of concern – subsequently named Omicron by the World Health Organisation – which could be significantly more transmissible than the Delta variant, and against which vaccine or natural immunity may be less effective.

Scientists will not know for at least another two weeks if Omicron is, in fact, more transmissible and resistant to existing vaccines.

However, the market reaction on Friday was sharply negative across all risk assets, as governments around the world imposed travel bans on South Africa, despite the fact that the virus has already been found in Hong Kong, Israel, several European countries and the UK. European equity markets closed down between 4 per cent and 5 per cent on Friday, while US equities lost more than 2 per cent in the half-day that the market was open. Unsurprisingly, travel stocks were among the hardest hit.

The flight to safety benefitted the Japanese yen and US treasuries. The US 10-year bond yield fell more than 16 basis points to 1.47 per cent, and the market pushed back the expected start of the cycle from June to July 2022, with a total of two, rather than three, rate rises now priced in by the end of next year.

Oil prices also fell sharply on Friday on the back of travel restrictions and the fear of tighter restrictions on movement. Brent, the global benchmark for two thirds of the world’s oil, closed the week at under $73 per barrel, its lowest level in two-and-a-half months.

While this may eventually provide some relief for consumers and central bankers who are worried about high inflation, it remains to be seen whether these lower prices are sustained.

Opec+ is due to meet this week to decide on production increases for January and may decide not to increase production at all, which could provide some near-term support for oil prices. Thin liquidity in the holiday-shortened week may have exacerbated the moves seen in financial markets last Friday. However, the market reaction highlights just how fragile the global recovery from the Covid-19 pandemic is.

Vaccine coverage, even in many developed economies, remains below what is needed for herd immunity. Even with new treatments for coronavirus infections, healthcare systems can be overwhelmed by rising cases, leaving governments with little option but to reimpose restrictions, which would slow growth, or at worst, push economies back into recession.

At the same time, those restrictions could worsen supply chain disruptions, adding to inflationary pressure, even as growth slows.

It is early days yet and it is entirely possible that existing vaccines are still very effective at preventing serious illness, even if they do not prevent infection, from the Omicron variant of the coronavirus.

Booster vaccines adapted to be more effective against Omicron could be rolled out in a much shorter time frame than the first Covid-19 vaccines took to be approved and distributed last year.

However, until there is broader vaccine coverage, not just in wealthy developed markets but also in poorer developing countries, there will always be a risk of a new variant that threatens the gains the global economy has made.

It is early days yet and it is entirely possible that existing vaccines are very effective at preventing serious illness