A message from Dan Farmer

Living with virus mutations

With vaccination rates high and re-opening in full swing many of us felt 2022 would be the year we could ‘live with the virus’. However, Omicron has given us some food for thought, demonstrating that living with the virus will likely mean facing into many years of new variants.

Omicron is the most recent COVID-19 manifestation of the mutation process that will see new variants replace existing strains. We’ll clearly need to adapt to this process, much like we do with the seasonal variants of the flu (influenza) for example. This could involve booster vaccinations and a tweak to vaccines to counter evolving strains.

While a new variant was expected, we shouldn’t downplay Omicron. At the time of writing, early comments on vaccine efficacy and symptom severity, while cautiously optimistic, are probably too speculative for us to form any solid views. The current situation in the UK, where Omicron cases are doubling every 2-3 days, is troubling so whether Omicron proves more virulent and whether vaccines still offer good protection are issues we’ll keep a close eye on.

Looking at the bigger picture, the key concern is around how virus variants are evolving – do they become more transmissible but less potent, or increase in severity, overwhelming healthcare systems? A sustained surge in hospitalisations and deaths from new variants, with vaccination efficacy falling to very low levels, is the main threat to our ability to live with the virus.

Medical scientists will no doubt be fighting against the virus and mutations for many years to come as each new strain replaces the one before. That said, compared with 2020, we’re far more knowledgeable about the virus and research continues to improve at a rapid rate.

An economic shift already in play

While some travel plans may be on hold for now, what are the economic and market impacts of living with a virus that continues to evolve? Well, there’s a long way to go but we shouldn’t expect a repeat of high levels of market uncertainty we saw in March 2020.

Policy makers globally have instated massive stimulus measures to support economies through the first phase of the pandemic and this has driven a strong rebound in growth and supported markets. However, a side effect has been surging inflation, particularly for goods prices, as supply chains struggle to keep up with rising demand.

The lift in inflation was initially thought to be largely transitory due to the pandemic but as we sit here today it looks more sustained and aligned to changes in the underlying structure of the global economy that the pandemic has exposed.

• China, the world’s engine room for goods production since 2000, slowing and re-anchoring its growth to the domestic economy
• US imposing tariffs across a swathe of Chinese goods
• An ageing population reducing the supply of labour and increasing labour bargaining power

The massive policy stimulus following the pandemic has likely brought forward the implications of these trends.

Reflecting the more positive economic backdrop, there have already been official interest rate rises in sizeable emerging economies, such as South Korea, Brazil, and Mexico^[1], as well as Norway,^[2] and New Zealand,^[3] among advance economies, in recent months. Meanwhile, the Reserve Bank of Australia (RBA) Governor Philip Lowe’s November statement^[4] no longer included a crucial line saying official interest rates will remain on hold until 2024.

In America, the US Federal Reserve announced a US$15 billion a month reduction^[5] of its massive asset purchase program, which has suppressed US and global interest rates. In addition, markets have moved to bring forward when they expect the US Federal Reserve to start lifting rates.

Whilst it remains possible that the current or future virus variants could have a severe impact as in 2020, on balance this is unlikely, primarily because we know more and can tweak vaccines and more effectively test and trace. However, a serious outbreak of the virus that results in a significant surge in deaths and hospitalisations would likely see policy tightening pushed out.

An economic shift already in play

On balance, future variants and associated infection waves will become the new normal. A key issue for investors is whether the current lift in inflation is transitory and will abate as we learn to live with the virus, or if it reflects deeper structural shifts in the global economy. There is considerable evidence that the pace of inflation may be somewhat greater than the last 20 years. That said the chances of getting assessments right at this phase is unclear, so diversification and risk management are key.

Regardless of the evolution of the latest COVID-19 mutation and inflation, the interest rate outlook will continue to occupy a lot of investor attention as we head into 2022. The prolonged low interest rates of the post-GFC era may have conditioned us to think of them as normal, but there’s nothing normal about official interest rates hovering near zero and when adjusted for inflation being well into negative territory. It suggests something is very amiss across advanced countries that interest rates have stayed so low^[6] for so long.

Fixed income markets have been troubled by levels of inflation not seen in years. Our fixed income team have been identifying the appropriate strategy blend (including assets such as high-quality credit, floating rate, relative value, low duration, emerging market and high yield or private debt) to deliver through this next phase. Clearly an active approach to fixed income is the key to facing into the current market environment.

As the next phase of the market cycle plays out, we’re continuing to accumulate returns from a range of different sources. While we keep a watchful eye out for potential threats to portfolios, such as Omicron, our longer-term view, anchored by strategic asset allocation, offers a robust risk-managed approach to support your clients to achieve their financial wellbeing goals.

On that note, I’d like to wish you all the best for a restful break over the holidays. I look forward to bringing you further insights in the new year.

[1] Brazil raises interest rates as it struggles to tame inflation. Michael Pooler, September 23, 2021, https://www.ft.com/content/2aba282a-e1ea-4533-ae36-375c16020565

[2] Norway raises interest rates, says another hike likely in December. Victoria Klesty and Nerijus Adomaitis, September 23, 2021, https://www.reuters.com/world/europe/norway-raises-interest-rates-says-another-hike-likely-december-2021-09-23/

[3] New Zealand hikes rates for second straight month as inflation risks grow, November 24, 2021, https://www.reuters.com/markets/rates-bonds/new-zealand-hikes-rates-second-straight-month-inflation-risks-grow-2021-11-24/

[4] Media Release: Statement by Philip Lowe, Governor: Monetary Policy Decision. 2 November 2021, https://www.rba.gov.au/media-releases/2021/mr-21-24.html

[5] FOMC Press Conference, and Federal Reserve issues FOMC statement, November 03, 2021, https://www.federalreserve.gov/newsevents.htm

[6] F13 International official interest rates, https://www.rba.gov.au/statistics/tables/xls/f13hist.xls

Please note: Past performance is not indicative of future performance.