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08 December 2021
INFLATION is the critical issue in financial markets -- and consequently how the US Federal Reserve and other central banks respond.
But the Omicron variant of Covid-19 in the short term has created greater uncertainty.
Still, it may not be a negative for markets says Michael Blayney, who heads up Pendal's multi-asset funds.
Omicron introduces uncertainty because it widens the potential range of outcomes -- but there's also a chance it will strengthen the re-opening trade.
Already on Wednesday we saw a bounce in markets on the back of subsiding Omicron fears.
The risks of Omicron are balanced, Blayney says.
"There's an outcome in which Omicron is more contagious, but milder and outcompetes Delta.
"That's the one we all hope for. It would be good for the reopening trade.
"Or there's the outcome where there's many mutations and the efficacy of vaccines isn't as good."
The emergence of the new Covid variant has complicated the global economic outlook. The most recent inflation reading in the United States shows price rises of 6.2 per cent in the 12 months to October 2021. That's the highest in more than 30 years.
Newly re-appointed US Fed chair Jerome Powell has indicated the central bank will taper its bond purchases. Market watchers now expect interest rate increases next year.
"It's interesting that Chair Powell wants to drop the transitory label from inflation. The Fed is targeting average inflation and now it's had a bit of inflation, the average shifts up."
Time to re-evaluate
The change in tack on inflation and the emergence of Omicron should trigger a re-evaluation of portfolio positioning.
"We've been a bit more pro-growth for the last 12 months," Blayney says. "But we have been bringing that back.
"That doesn't mean going underweight equities. Instead, it's about looking for relative value opportunities. We like UK equities but don't like French equities, for example."
Blayney also argues the benefits of being exposed to higher volatility.
"Part of our investment process enables us to trade instruments on volatility. When you start to see a bit more financial market stress and an uptick in volatility, you can buy instruments that tap into that. We are essentially long volatility exposure.
"We are still underweight bonds," says Blayney. "Bond yields have fallen a bit with some flight to safety as a result of the Omicron variant. But the reality is we've got high inflation, tapering and the potential for interest rate rises next year in the US.
"That creates a backdrop which is quite negative for bonds, and you're starting off with pretty low yields to begin with.
"Add in the idea that Omicron is actually part of the lessening of the pandemic, there could potentially be big trouble for bonds."
What's most important right now is to be vigilant and able to move your portfolio quickly, he says.
"You've got to be active and prepared to shift your views and positioning quickly.
"There will be more information on the Fed tapering and Omicron in coming weeks.
"Whatever you position, you need to be willing and ready to move those around as the situation changes."
Written By Michael Blayney
Funds operated by this manager:Pendal Total Return Fund
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