Summary

  • The new Omicron variant is unwelcome news and markets have treated it as so. It is still too early to gauge the potential impact to economic activity and the outlook it will have for asset markets but initial analysis that it could be less severe offers some hope for the months ahead.
  • Despite US equity markets making headlines for hitting new highs, strong corporate earnings growth through 2021 means they are slowly creeping into their still elevated valuations. Over the coming months, markets face the twin headwinds of winter and the continued rise of Covid cases as well as less supportive central bank policies. Both have the capacity to unsettle markets.
  • Whilst the initial economic rebound from last year’s shutdown has been swift, continued recovery faces the headwinds of the Covid disruption and supply bottlenecks, both of which stand to suppress growth. Whilst 2021 saw above-trend growth rates, growth expectations for 2022 have edged lower of late.
  • Central banks are winding down some of their ultra-supportive policies. The Bank of England raised interest rates in December and curtailed its bond purchases (QE); the ECB is set to cease its Pandemic Emergency Purchase Plan in the early part of the year. The US Federal Reserve, the most crucial of all central banks, said it will increase the pace at which it tapers bond purchases to $30 billion a month and projected three quarter-point interest-rate increases in 2022, another three in 2023 and two more in 2024.
  • Tightening central bank policy raises the prospect of rising volatility if messaging gets misconstrued. We still believe the ‘lower for longer’ interest rate narrative continues, but we are transitioning from an ‘ultra-loose’ to ‘loose’ policy which will see yields rise. A slowly rising rate environment, with a lower terminal rate, remains our base case. We continue to use strategic bond funds and short-dated fixed income funds to shelter from rising yields.

  • Inflation needs to be watched as supply disruptions are becoming more stubborn and taking longer to resolve than anticipated. Transit and raw material costs may well begin to alleviate but what remains in question is how much real wage inflation will become embedded as we go through annual pay rounds across the economy. Nominal wages may be on the rise, but real wages are being eroded by inflation.
  • The new Omicron variant highlights the impact Covid has to move markets. Increased restrictions are being implemented in some countries but as we write, a return to full, protracted lockdowns look less likely but remain a source of risk for many regions, particularly given the unequal global distribution of the vaccine.
  • Through the course of 2021, sterling strengthened against both the Japanese yen and the euro but marginally weakened against the US dollar during the final quarter.
  • The price of Brent Crude fell sharply as Omicron emerged and raised concern about slowing economic activity, finishing the year at $75 / barrel, significantly higher than it started but off its year highs. Gold rose through December to $1830, but still closed the year below its starting price of just over $1900.

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