Omicron leads to the risk of US stagflation: Economists

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Washington: US stagflation, that awful combination of rising inflation and declining growth, is likely to be resurrected after several news related to last week’s economy and COVID-19.

The rapid spread of the new Omicron strain of coronavirus has not just overwhelmed the healthcare infrastructure across the globe, but also made financial markets in the United States.

The pace at which it is spreading – the strain was discovered in Africa earlier this month and nine countries have now reported cases – threatens to disrupt whatever little normalcy the people have seen in recent months.

The World Health Organization (WHO) has categorised Omicron as a “variant of concern” because of the higher risk of infection and the possibility of vaccine evasion. Several countries, including the US, Canada and the UK, announced restrictions on travel from countries in southern Africa.

Risk assets sold off, including sharp losses in stocks worldwide. The VIX, often thought of as a “fear index,” surged nine points to more than 27 on Friday. Oil prices fell more than 10 per cent. Meanwhile, yields on US government bonds, including a 16 basis points decline in the 10-year Treasury, registered their biggest one-day move since last year.

The markets’ sharp moves were consistent with a reduction in overall economic dynamism and a partial rotation back to at-home activities because of COVID-related disruptions. This was also deemed to lower inflation, according to the immediate move in market measures of inflationary expectations.

As last week’s data confirmed, the drivers of high and persistent inflation continue to broaden, making further increases likely in the months ahead. Indeed, core PCE is already on track to reach 4.5 percent by the end of the year, if not higher. This will continue to fuel wage increases, which — combined with continued supply disruptions amplified in the short term by the production and transportation effects of the new COVID-19 variant — will fuel inflation well into next year.

The growth outlook is more uncertain. With still solid balance sheets, the household and corporate sectors are still strong enough to power growth through another COVID-19 shock provided they do not face significant policy- and market-related headwinds.

Omicron was first discovered in samples from southern Africa earlier this month. As more and more scientists started studying the latest world-threatening infection after Delta, it emerged that Omicron contained more than 30 mutations – the highest till date in any of the variants of coronavirus.

 

 

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