USD Rates: Factoring in Omicron risks in a calmer fashion

Fed normalisation on track, risks of delays.
Eugene Leow30 Nov 2021
    Photo credit: Unsplash Photo

    Fears over the Omicron variant eased somewhat overnight. This is more apparent in the equities space (especially the Nasdaq) but less so in US Treasuries. While the curve did steepen, longer-term yields ended the trading day only modestly higher than what they closed at last Friday. 10Y yields are trading close to 1.50% (off the intraday high of 1.56%), some 13bps below the level seen before the variant news hit. 

    We think that market pricing is reasonable, albeit low compared to fundamentals. Uncertainties on this variant would weigh on yields as investors take out some insurance (compressing term premium and lowering Fed hike bets) in case of bad economic outcomes. At the minimum, there already is additional economic damage taken as more stringent travel restrictions get put in place. Even if this turns out to be a false alarm, it would still be a few weeks before further reopening in international travel takes place. If the Omicron variant turns out to be as potent as Delta, global economic growth would be impacted for months (delaying the normalisation higher in US yields/rates).  

    We think that dips in USD rates should be paid as we do not think that Fed normalisation would be derailed. To be sure, the threat of lockdowns points to downside risks to growth and upside risks to inflation. If more weight is placed on growth (as is widely expected of the Fed), then there could be some delays in withdrawing loose monetary policy. Before the variant news hit late last week, market participants were gravitating towards accelerated taper in December as a base case. The probability of that taking place has diminished somewhat but these tightening bets could resurface quickly if positive news on Omicron emerges. Sustained momentum in the US economy (watch payrolls this Friday) would also help. 

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]

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