This fact may suggest that the current investor angst, based on available information, is not centered on the Omikron breakout, but rather the change in the tone and actions of the main Central Banks – especially that of the U.S. Federal Reserve. Stock volatility picked up after the Federal Reserve chairman commented this past week that officials should consider removing pandemic support faster and that inflation was no longer ‘transitory’. As we have written before, it is important to recognize that high inflation has historically become an equity problem only once the monetary authorities decide to fight it – through higher interest rates. The market is starting to sniff a change in Central Banks’ tolerance for persistently high inflation and the risk that this will crimp future growth expectations. This emerging concern may be gleaned from the sharp reduction in the U.S. yield spread (graph below) this past week. The confluence of higher inflation, a robust economy and a tightening Fed should mean curve steepening. It did initially. That is because the growth outlook was (and in many ways still is) favourable. But, as Fedspeak has become increasingly inflation-focused, the potential for demand destruction or over-tightening has increased.
Source: Bloomberg Finance