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Market Outlook: Equities treading water ahead of monetary policy announcements

Last week pandemic-related market fears calmed somewhat, leading to increased risk appetite. In the United States the broad S&P 500 equity index set a new all-time high last Friday, having gained 3.8% between December 3 and December 10. Nordic stock markets also shook off their worries, with Sweden’s All-Share Index (OMXSPI) climbing by 2.4% last week. Since then, both indices have lost a bit of ground. Last week 10-year US Treasury yields rose from around 1.35% to 1.50 before dropping to 1.48%. So far this week (December 13-14) they have again fallen below 1.45%.

The world

An intensive central bank week, with several interest rate and other policy announcements

In the coming days, a number of central banks will be making their December announcements. This evening Central European Time (December 15) the US Federal Reserve holds its press conference. Tomorrow (December 16) Norges Bank, the Bank of England and the European Central Bank (ECB) will make their announcements, and on Friday (December 17) the Bank of Japan and Russia’s central bank will issue theirs.

The Fed is expected to approve faster tapering of its stimulative asset purchases, which would imply an earlier start to key interest rate hikes. ECB bond purchases will also be a focus of market attention. In Norway the central bank has clearly signalled a December rate hike, but there is growing uncertainty due to increased COVID-19 transmission (more below). Although we are still inclined to believe there will be a rate hike, Norges Bank may choose to hold off and instead indicate that it will wait until early 2022. Overall it is close to a 50/50 situation.

The United States

High US inflation figures for November

On December 10 the Bureau of Labor Statistics reported that year-on-year US inflation reached 6.8% in November, the highest rate since 1982. Core inflation, excluding food and energy, was 4.9%. Since these figures were in line with expectations, financial markets reacted calmly to the news.

The Nordic countries

Swedish inflation reaches 3.6%

Yesterday (December 14) Statistics Sweden published its inflation figures for November. Measured as CPIF (the consumer price index excluding interest rate changes), year-on-year inflation ended up at 3.6% compared to 3.1% in October. This is the highest level since December 1993. Among the factors contributing to Sweden’s high inflation rate are rising energy prices.

Norwegian government tightening restrictions more

The Omicron variant of COVID-19 is spreading rapidly in Norway, which has its largest number of coronavirus hospitalisations to date. To reduce transmission of the virus and prevent the health care system from being overwhelmed, on December 14 the government announced further restrictions that will be in force during a four-week period. This includes limiting public and private gatherings to a maximum of 20 people, banning all alcoholic beverage service at bars and restaurants and urging everyone who can work at home to do so.

Our market view

Uncertainty about outbreaks of the Omicron variant initially generated some stock market turmoil, but recent reports about the limited risk of severe illness have had a calming effect and resulted in more stable markets. Although from a human perspective there are continued reasons for concern, we believe it will take a lot more negative news about the new virus strain before it has any major impact on economies and financial markets. This hypothesis is supported by the mild economic effects of recent COVID-19 waves and the fact that after nearly two years of the pandemic, we are learning to better manage any effects.

On the other hand, inflation worries continue to disrupt financial markets. The inflation surge of recent months has been both bigger and more long-lasting than expected, but so far it has been manageable in the markets. The same applies to current forecasts that inflation may climb further early in 2022, before declining. This is still our main forecast and that of most other observers – but it is now being challenged. Though it is unlikely that inflation will get stuck at the unusually high levels we see today, especially in the US, there is a growing risk that it will not fall to central bank target levels (around 2%). Continued inflation at higher levels than this would force central banks to act, including larger key rate hikes than in current forecasts.

This is not our main scenario, however. We are still expecting inflation to fall gradually next year, but partly due to higher inflation levels the US Federal Reserve will unwind its bond purchases faster than previously forecast during the first half of 2022 and will begin a period of key rate hikes during the second half. We believe the federal funds rate will reach 1.5% over the next two years and that 10-year US Treasury yields, a major alternative to equity investments, will reach the 2.5% range. These are yields that we believe are completely manageable for stock markets and investors, especially if our economic growth forecasts prove correct. But looking ahead, worries about larger or faster upturns in interest rates and yields are among the biggest risks to keep an eye on.

In our main scenario the global economic recovery will continue next year, with growth well above the historical average. By 2023 growth will fall to more "normal" levels. This suggests continued good earnings performance by listed companies, which have also shown an impressive ability to generate earnings and manage disruptions in recent quarters.

We thus foresee some continued upside stock market potential for another while, but this presupposes that the Omicron variant can be managed without any major economic effects and that the inflation outlook will not worsen. But inflation in itself is not the only problem; if investors become more and more concerned about inflation, this may lead to rising interest rates and bond yields that have a negative impact on stock markets.
As long as rates and yields do not climb too rapidly, there are solid hopes that positive stock market returns will continue into next year.