GLOBAL CREDIT BULLETS | Monday, 6th December 2021

Omicron – Surely faster, maybe milder.
The past week has been characterized by fears on the omicron variant. Information is very scarce for now, but the variant appears to transmit faster than previous ones. In South Africa, where the variant was found, cases have more than doubled over one week. The beta and delta variant took a few months to become dominant, while the omicron took only a few weeks. Evidence on severity is more mixed. South African data show a relatively low level of hospitalizations, and a lower fraction of severe cases compared to previous waves. Health institutions around the world are warning against this conclusion, though, as the evidence is very preliminary. Moreover, a mild disease but a faster transmission may still be bad news, as the absolute number of people requiring healthcare may end up higher than previous waves. The key market questions remain vaccine escape and chances of more lockdowns. On the former, major vaccine producers will present results over the next two weeks. Preliminary observations are somewhat encouraging as no country in Europe or Africa is displaying a marked increase in hospitalizations. On the latter, restrictions are increasing into Christmas but maintain a “softer” form (limited in time or to selected groups of people, i.e. the unvaccinated ones).

Markets – Down with the elevator.
The reaction to the omicron scare has been strong. European equities corrected some 10%, with banks, energy and travel underperforming. Oil is now down 20% from its October peak. Most reopening and travel-related names have corrected 20-30% and are now back to pre-vaccine levels. On the other side, credit has not corrected much, except emerging markets. The same is true for growth/tech stocks, which held well thanks to tighter rates. The Nasdaq index is still close to the year high, bringing the valuation gap between value and growth at the 12 months high. Overall, we thus think the opportunity is in reopening/value, mostly on the equity side. This is the area where valuations are most sacrificed, and where markets have priced a scenario similar to the one prevailing before vaccines (e.g. unlikely to fly for the next two years). Convertibles in this area look overall attractive as risk-reward is skewed in favour of investors. We maintain a more wary attitude on credit, as the correction has been broadly mild and inflation is likely to persist in 2022.

Inflation – Not transitory anymore.
Last week, the Fed turned relatively hawkish on inflation. For the past few months, Chairman Powell has insisted calling inflation data “transitory”, giving a dovish tilt to the Fed tightening step. On a speech last Tuesday, Powell recognised the definition is not fit anymore, as inflation above 4% now lasts since March and the underlying components are giving a worrying picture too. We believe this marks an important step. Intellectually, the Fed is giving in to the “transitory” dogma that characterized the past few months. This puts inflation at the top of US priorities and paves the way for more recognition from other global central banks. Practically, transitory inflation has been the main driver of the pushback against 2022 hikes, so the turn represents a potential green light to faster taper and a discussion of hikes in spring. Over the next few weeks, we will have the Fed, BoE and ECB meetings. Given omicron risks, a hawkish turn is postponed to 2022 for all of them. The Fed will likely avoid to accelerate tapering, and the BoE will postpone hikes once again. The ECB is likely to tilt APP as the PEPP end approaches in March, but without major hawkish turns. In 2022, tightening will turn more hawkish to fight inflation, which is likely to create more volatility, especially given the level of valuations in credit markets.