KUWAIT: A combination of worries over the emergence of the Omicron virus strain, increasing virus-related restriction measures across Europe and slower growth in China have threatened to knock some of the momentum from the global economic recovery of late. Key equity market indices in the US, Europe and Japan all fell 3-5 percent in November, although remain up significantly year-to-date. At the same time, anxieties over rising inflation driven by strong demand, loose policy and supply bottlenecks have intensified (especially in the US and Europe).
Indeed, for most major western central banks, high inflation has become the dominant concern and the US Fed in particular looks set to accelerate its policy tightening program imminently – that is unless the worst of the latest concerns about Omicron (and its potential impact on economic activity) materialize. Oil prices also dropped sharply in late November, from $80 to temporarily below $70, though have since partially recovered. OPEC+ opted to stick to its production increase schedule, despite expectations that it might pause given the risk of softer global oil demand.
Fed seen accelerating tapering
US economic growth slowed sharply in Q3 amid the ongoing supply chain shortages and the spread of the Delta variant. GDP growth for Q3 stood at an annualized 2.1 percent q/q, missing expectations and sharply lower than the 6.7 percent growth in Q2. Consumer confidence (as measured by the Conference Board’s index) continued to weaken, falling to 109.5 in November, the lowest since February 2021, with high inflation the main culprit.
Despite a relatively weak increase (210k) in non-farm payrolls in November, there are many indicators that the recovery in the labor market is solid: the unemployment rate dropped to 4.2 percent in November while labor participation increased to 61.8 percent, both at the best levels since the outbreak of the pandemic.
In addition, new weekly jobless claims continued to trend downwards, averaging 208k for the past two readings, which is in line with the level seen just before the pandemic’s impact was felt in the US. GDP is expected to grow by around 4 percent (annualized) in the final quarter of the year.
Meanwhile, Congress finally passed the $1 trillion infrastructure bill, unlocking funds to a wide range of areas including roads/bridges, railways, ports/airports and water/energy. In addition, the House passed President Biden’s social safety and climate bill (Build Back Better Act) for a total value of $1.7 trillion, which is less than half the original target of $3.5 trillion.
A surge in COVID infections across Europe through October and November – even in some countries with high vaccination rates – ushered in a new range of restrictions that is set to slow the economic recovery in 4Q21 and possibly beyond. This included tighter rules for unvaccinated people in Germany and an even harsher full lockdown in Austria.
The economic impact of this wave is likely to be less severe than that associated with earlier ones, not least because vaccinations have lowered the risk of infections causing severe disease (and thus changing people’s behavior) and firms and individuals are better adapted to restrictions than before. Still, governments look set to adopt a precautionary approach in terms of public health policy and with some health systems already under severe pressure, restrictions could even tighten if the Omicron variant turns out to be more infectious or deadly than earlier virus strains.
So far, signs of any negative impact on economic activity have been limited. The Eurozone composite PMI remained in solid growth territory at 55.4 in November and up from 54.2 in October; however, the survey’s drop in business confidence suggests that the improvement could be short-lived as firms anticipate pandemic-related disruption to increase – potentially worsening supply chain issues.
Similarly, the unemployment rate has continued to fall reaching 7.3 percent in October (versus a pandemic peak of 8.6 percent last year), but would likely capture a softening of economic conditions only with a lag. But overall, having picked-up to 2.1-2.2 percent q/q in both Q2 and Q3 2022, Eurozone economic growth is now set to slow to around 0.7 percent in Q4, with output only just exceeding pre-Covid levels and still far from its pre-pandemic path. Looking ahead, growth in 2022 is seen at around 4 percent versus 5.1 percent this year.
Meanwhile in the UK, the Bank of England surprised the markets by leaving interest rates on hold in November versus expectations of a 15 bps increase (from 0.1 percent to 0.25 percent). The hike could now come at the December 16 meeting instead, although given worries over Omicron even this move seems uncertain. UK inflation jumped to a 10-year high of 4.2 percent y/y in November driven by energy and fuel price rises and is forecast to peak as high as 6 percent next April.
Japan’s economy contracts
Japan’s economy contracted by a more-than-expected 3.6 percent annualized rate in the third quarter (-0.9 percent q/q). The decline, which followed a gain of 2.0 percent in 2Q21, was caused by a combination of supply-chain disruptions and the state of emergency that was extended during the quarter to contain resurgent COVID-19.
Fixed investment (-8.2 percent) and private consumption (-5.1 percent) were especially hard-hit. Economic growth has struggled to take off while the pandemic persists, forcing policymakers to maintain extensive fiscal and monetary support, including a new, record-breaking stimulus package worth 56 trillion yen ($490 billion) which Prime Minister Fumio Kishida unveiled in mid-November.
Chinese GDP growth slows
China’s GDP growth softened to 4.9 percent in 3Q21, easing from record rates set earlier in the year. The quarter was notable for serious energy shortages affecting businesses and industry, a property market slowdown that almost caused real estate giant Evergrande to default on its obligations, and repeated lockdowns imposed on cities across the country as China persevered with its zero tolerance policy towards COVID-19.
The energy crunch was exacerbated by government restrictions on carbon emissions and coal usage, which along with soaring commodity prices more generally, pushed producer price inflation in October to its fastest rate since 1995 (+13.5 percent y/y). Inflation pass-through to consumers was substantially less – the CPI rose by only 1.5 percent y/y in comparison – suggesting that businesses had so far borne the brunt of the surge in raw materials and input costs.
India’s GDP grew by 8.4 percent y/y 3Q21 (2Q of FY21-22) moderating from the exceptional 20 percent in 2Q21, mainly on a fading base effect. By sector, growth in Q3 was underpinned by private consumption (8.6 percent), government spending (8.7 percent), investment (11 percent) and exports (19.6 percent). Activity and sentiment was also helped by an improvement in virus-related conditions, with new daily infections down to pre-second wave levels of around 26,000 by end-September versus a peak of nearly 400,000 in May (they have since fallen further still to just 8,000).
Oil prices drop
Having been above $80/bbl for several weeks, Brent crude oil prices plunged in late November, rattled by the spread of the Omicron variant and the prospect of accelerated Fed tapering of its asset purchase program. Tighter monetary policy is typically bearish for commodities. International crude oil benchmark Brent dropped 16.4 percent in November to close at $70.6/bbl, its worst monthly performance since March 2020. Moves by large oil consuming nations to coordinate a release from their strategic oil reserves (to lower domestic fuel prices) also helped shift sentiment in that month in a more bearish direction. About 85 mb of crude oil is scheduled to be released by the end of 1Q22. By mid-December, oil prices had partially recovered to $75.
OPEC+ held its ministerial meeting on 2 December amid speculation that it would react to the SPR releases and the emergence of Omicron by pausing or even reversing the planned supply increase for January. OPEC+ has consistently maintained that oil demand remains fragile while the virus continues to spread and that oil balances will swing into a heavy surplus as early as 1Q22, posing a downside risk to prices. In the end, OPEC ministers opted to continue increasing supply at the monthly rate of 400 kb/d but also gave themselves the option of adjusting production on the fly should oil demand weaken. The actual supply increase may fall short of target due to supply outages and capacity constraints among some members.
As 2021 draws to a close, the Omicron variant has introduced more volatility into the oil market, though it is too soon to gauge the impact on oil demand. In terms of supply, the impasse on Iran’s nuclear program means the timeframe for the return of its oil has been pushed back, simplifying matters a little for OPEC+, which can focus on adjusting supply to demand-affecting events.