Friday's Market Minute: Bullish Countertrend Rally Hits a Wall

Equity markets have whipsawed in the past week as investors have worried about the potential effect of Omicron and the Federal Reserve having signaled its willingness to speed up its tightening of monetary policy. There was a post-Omicron countertrend rally that began Monday, but the markets seem to think it’s too soon to interpret the recent data. There is still a high degree of uncertainty about the pandemic, added to thin trading conditions during the holiday season means market moves are more amplified than they otherwise would be. 

When you compare the recent market reaction to that of other COVID waves and the Delta variant, what's different this time is that there was not a flight to big tech stocks or stay-at-home plays. Markets appear laser focused on monetary policy and consumer response to the virus variant. What appears to be really weighing on equities, especially growth stocks, is the presence of a newly hawkish Fed chief post re-nomination. Omicron aside, markets will engage on any upcoming clues about how fast the Fed will need to withdraw stimulus and how long inflation stays. Additionally, the rating agency Fitch recently downgraded Chinese property developer Evergrande’s credit ratings to “restricted default” which makes credit markets edgy due to potential systemic financial sector liquidity constraints. 

As this year draws to a close, it is evident how several major central banks forecast inflation to be much lower than it turned out to be. US inflation has exceeded the Federal Reserve’s target in recent months because of coronavirus-related supply chain disruptions, higher fuel prices and rising rents. The question going forward is whether they will withdraw the stimulus too quickly for markets as they seek to contain the inflation they have nurtured. Year-to-date, a 22% gain for the S&P has proven to be good returns for investors even as the U.S. economy and inflation has kept running hot.

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