Markets tumbled after Fed Chairman Jerome Powell signaled the Fed may accelerate the winding down of its monthly asset purchases, despite concerns about the Omicron variant. Anthony Okolie speaks with Michael Craig, Head of Asset Allocation and Derivatives, TD Asset Management, about the implications.
Print Transcript
- Michael, stock markets are selling off today amid the uncertainty around the new variant. But we also got some surprising comments from Fed Chairman Mr. Powell. What do you make of today's market action?
- Hi, Tony. It's really a continuation of Friday where we saw pretty epic volatility amidst a much more reduced trading session, and the US was generally on a holiday. But it's been pretty volatile since last week, and today was a continuation of that, A, with still uncertainty with the Omicron variant and, B, Powell came out today more hawkish than perhaps the market was expecting.
- And you mentioned he is more hawkish. Do you see a scenario where with the Omicron variant where you could see the Fed maybe reconsidering their accelerated taper timeline?
- For the Fed to back off and look to cut asset purchases quicker, you really need to see the Omicron variant become a much ado about nothing, which I'm not certain I want to take that view. But if this variant becomes quite not harmful, not nearly as contagious, and vaccines are still able to protect people from it, then I think the Fed will continue to push ahead with its course to reduce asset purchases faster than markets was expecting, which would then probably pull forward rate hike expectations next year.
- And given this latest drop, do you see this as a more sustained pullback, given the risks around the Omicron variant?
- So the way we are thinking about it is that we had actually pulled back some of our risk a few weeks ago, more so on valuation than anything else. We just thought that there was a lot of good news priced into the market and that likely the market would have a breather or go sideways for some time. And we just wanted to build out some optionality in terms of taking advantage if we did have a sell off.
This round, you got to understand going into this, the market wasn't exactly cheap. We were already concerned about inflationary pressures. And now you're hit with things that were off the radar of investors. I think COVID's always been the background. But essentially we've gone for some time now without an acceleration of cases. And now we have a new variant that really no one has a good understanding or handle on where it's going to go.
You had a handful of executives from various pharmaceutical companies out with varying degrees of analysis on this, somewhere between it's vaccine resistant to overreacting. And markets hate uncertainty. And so as a result, we're seeing assets reprice materially. Powell's comments today will probably be taken at-- the people will see the headline and think that it's very hawkish.
I would say it's a bit more balanced. I think the Fed is acknowledging the fact that inflation is more entrenched than previously thought and also mentioned that they really don't know the effects of the Omicron variant yet, and we'll act as more information comes due. So lots of uncertainty, and that, as a result, is leading to a material sell off in risk assets today.
- You also mentioned-- as you mentioned, markets hate uncertainty. And we've also seen a sudden spike in volatility. In your mind, do you think volatility is here to stay?
- I don't know if it really ever left. We've been more of a thematic thought process that we're entering a decade-- we've entered a decade that was going to be marked by materially higher growth and inflationary volatility than what we've come out of in the previous decade, where it was incredibly low. In fact, in the 20-teens, growth and inflation volatility were as low as they've ever been on record. And we just didn't think that was sustainable for a number of reasons.
And so we don't really think volatility is going anywhere. These are environments, as an active investor, you kind of cherish because it provides opportunity. It doesn't feel good as you're going through it. But ultimately this volatility is actually quite helpful to us in terms of being able to position our assets.
And I think it's something that we just need to get used to. It's not going away. And even as this new cycle passes, we would expect things to come out of the woodwork in the horizon that will lead to accelerated volatility in the months and years to come.
- Well, what will you be watching in the next few weeks?
- Well, we're going to get a sense to see about the spread of Omicron and the severity of it. I think it's one thing for it to be more infectious. And it's a completely other thing to see it lead to ICU wards and hospitals filling up with sick people. The latter would be very bad, obviously, from a health care perspective and from a financial markets perspective.
The whole narrative about reopening, I think, gets pushed back six to nine months. And so to me, that's kind of topic number one. The second, I'd say, is the Fed is certainly starting to pivot away from transitory inflation. Powell said we need to retire that word today.
Markets took that as very, very hawkish. I think it's a bit more nuanced. I think this inflationary backdrop is actually quite complicated. There are certainly things that are transitory that are really directed towards COVID and supply chain issues and demand peaks, et cetera. And then there are some longer-term issues, particularly in the energy space, where there's been material underinvestment in energy.
We are in a world where we're starting to frown upon the use of fossil fuels. But we have no alternative energy source to mop up that excess demand. And so this is going to be an area that I think creates a lot of inflation and angst not so much in 2022, but for the remainder of this decade.
- Michael, thank you very much for your time.
- My pleasure, Anthony.
- Hi, Tony. It's really a continuation of Friday where we saw pretty epic volatility amidst a much more reduced trading session, and the US was generally on a holiday. But it's been pretty volatile since last week, and today was a continuation of that, A, with still uncertainty with the Omicron variant and, B, Powell came out today more hawkish than perhaps the market was expecting.
- And you mentioned he is more hawkish. Do you see a scenario where with the Omicron variant where you could see the Fed maybe reconsidering their accelerated taper timeline?
- For the Fed to back off and look to cut asset purchases quicker, you really need to see the Omicron variant become a much ado about nothing, which I'm not certain I want to take that view. But if this variant becomes quite not harmful, not nearly as contagious, and vaccines are still able to protect people from it, then I think the Fed will continue to push ahead with its course to reduce asset purchases faster than markets was expecting, which would then probably pull forward rate hike expectations next year.
- And given this latest drop, do you see this as a more sustained pullback, given the risks around the Omicron variant?
- So the way we are thinking about it is that we had actually pulled back some of our risk a few weeks ago, more so on valuation than anything else. We just thought that there was a lot of good news priced into the market and that likely the market would have a breather or go sideways for some time. And we just wanted to build out some optionality in terms of taking advantage if we did have a sell off.
This round, you got to understand going into this, the market wasn't exactly cheap. We were already concerned about inflationary pressures. And now you're hit with things that were off the radar of investors. I think COVID's always been the background. But essentially we've gone for some time now without an acceleration of cases. And now we have a new variant that really no one has a good understanding or handle on where it's going to go.
You had a handful of executives from various pharmaceutical companies out with varying degrees of analysis on this, somewhere between it's vaccine resistant to overreacting. And markets hate uncertainty. And so as a result, we're seeing assets reprice materially. Powell's comments today will probably be taken at-- the people will see the headline and think that it's very hawkish.
I would say it's a bit more balanced. I think the Fed is acknowledging the fact that inflation is more entrenched than previously thought and also mentioned that they really don't know the effects of the Omicron variant yet, and we'll act as more information comes due. So lots of uncertainty, and that, as a result, is leading to a material sell off in risk assets today.
- You also mentioned-- as you mentioned, markets hate uncertainty. And we've also seen a sudden spike in volatility. In your mind, do you think volatility is here to stay?
- I don't know if it really ever left. We've been more of a thematic thought process that we're entering a decade-- we've entered a decade that was going to be marked by materially higher growth and inflationary volatility than what we've come out of in the previous decade, where it was incredibly low. In fact, in the 20-teens, growth and inflation volatility were as low as they've ever been on record. And we just didn't think that was sustainable for a number of reasons.
And so we don't really think volatility is going anywhere. These are environments, as an active investor, you kind of cherish because it provides opportunity. It doesn't feel good as you're going through it. But ultimately this volatility is actually quite helpful to us in terms of being able to position our assets.
And I think it's something that we just need to get used to. It's not going away. And even as this new cycle passes, we would expect things to come out of the woodwork in the horizon that will lead to accelerated volatility in the months and years to come.
- Well, what will you be watching in the next few weeks?
- Well, we're going to get a sense to see about the spread of Omicron and the severity of it. I think it's one thing for it to be more infectious. And it's a completely other thing to see it lead to ICU wards and hospitals filling up with sick people. The latter would be very bad, obviously, from a health care perspective and from a financial markets perspective.
The whole narrative about reopening, I think, gets pushed back six to nine months. And so to me, that's kind of topic number one. The second, I'd say, is the Fed is certainly starting to pivot away from transitory inflation. Powell said we need to retire that word today.
Markets took that as very, very hawkish. I think it's a bit more nuanced. I think this inflationary backdrop is actually quite complicated. There are certainly things that are transitory that are really directed towards COVID and supply chain issues and demand peaks, et cetera. And then there are some longer-term issues, particularly in the energy space, where there's been material underinvestment in energy.
We are in a world where we're starting to frown upon the use of fossil fuels. But we have no alternative energy source to mop up that excess demand. And so this is going to be an area that I think creates a lot of inflation and angst not so much in 2022, but for the remainder of this decade.
- Michael, thank you very much for your time.
- My pleasure, Anthony.