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Omicron shows markets fell into groupthink on 2022


Outlooks have been challenged by a white swan event

The latest strain of Covid-19 brings an important lesson for financial markets: consensus is always a dangerous sign.

Mid-way through the fourth quarter of this year, market professionals had already built a clear picture of what they thought 2022 would look like.

Some tightening of monetary conditions was inevitable as central banks reacted to rising inflation and as the economy recovered from the coronavirus pandemic.

Borrowers would therefore find it trickier to navigate the markets, which would need to adjust to expectations of higher interest rates and lower excess liquidity.

But with the ink still wet on many outlook pieces, market participants are now wondering whether they should revisit some of their strongest predictions.

They appear have been blindsided by one of the more predictable and probable risks: that the world would need to deal with another major mutation of Covid-19.

Markets were clearly rattled when the latest variant, known as Omicron, was discovered last week. European equity indices lost about 4.5% of their value, 10 year US government bond yields dropped 15bp, and the iTraxx Europe Crossover index hit its widest level in over a year.

The spike in volatility was a sign of the perils of groupthink — even if it turns out the reaction is overdone and the new strain poses no extra problems.

In a heartbeat, market participants have gone from waiting for the European Central Bank to begin withdrawing support to wondering whether it could increase stimulus instead.

“Ironically, Omicron may have removed one of the greatest threats to global asset prices,” said one credit strategist.

`US Federal Reserve chair Jerome Powell put forward an alternative view on Tuesday, when he said the variant could actually add to inflationary pressures and strengthen the case for tapering.

Given that December is an important month for strategising, the timing of the discovery of the new variant should in fact be viewed as a blessing in the financial markets.

Borrowers will now hold off on their decisions about how exactly to approach 2022 until they have learned more about Omicron: Is it resistant to vaccines? Is it more transmissible? Is it more deadly?

They will also want to wait to hear more about the central bank response, with the ECB next set to meet on December 16.

There is no prospect of absolute certainty on either front, of course, but market participants will at least be able to proceed with a fuller picture of the risks they face in 2022.

Omicron is a reminder that nothing is set in stone — the course of the pandemic, the outlook for monetary policy, the future for asset prices.

But issuers and investors should now, at the very least, be able to reserve their surprise for black swans next year, instead of being spooked by white ones.