Why Interest Rates and Omicron are Scaring the Market

By: JT Martin

The last week has been filled with lots of volatility and speculation in the stock market, as investors continue to monitor and fear the possibilities of raised interest rates and the new and unknown omicron covid variant. These two factors has created a sentiment of uncertainty and fear within the market over the first week of December and may continue into the near future.

Federal Reserve chairman, Jerome Powell, stated last week that the central bank was ready to begin easing its monetary policies that have held interest rates near zero for almost the last two years. These rock-bottom interest rate levels encouraged borrowing at extremely high rates and made money extremely available to business and average Americans to help spur economic recovery from the covid-19 pandemic. Many credit this for the strength and speed with which the stock market was able to rebound from the drastic drop it made in the spring of 2020. Chairman Powell knows that this cheap money policy cannot be sustained, and inflationary concerns have become more serious over the past several months.

The reason investors are concerned about interest rates is because it affects the amount of money in circulation as well as affects the valuation of equities. It affects the amount of money in circulation very simply, when interest rates are low more people can afford the amount of interest needed to borrow money and will then encourage people to borrow money for all kinds of purposes, but as interest rates rise it become “more expensive” to borrow money because they amount of interest required for an investor to pay increases so less borrowing occurs and more money is being paid back through interest payments. The way that equities are affected by interest rates is through the method which they are valued. Stocks are reflections of present values of speculated future cash flows of a company or whatever entity is represented by the stock, and those cash flows are discounted at a certain discount rate which is built upon their borrowing rates. So, as interest rates rise, the projected future cash flows are discounted by a new, higher rate and therefore lower the stock price. While moving interest rates by 50 basis points or any amount may not seem like a drastic change or drop in value when using the example of a single stock, when it changed the value of every stock in the market it can huge effects on the market.

The rise of the new covid variant omicron also has weighed heavily on the market over the first trading week of December. The omicron variant has added to the fire of volatility that was already growing from interest rate concerns, and because there is still very little information known on the variant, concerns over it are new scaring investors. With very little data on how the current vaccines can protect against this new variant or the severity of it compared to the virus that affected the world in ways never seen before over the last two years. There is no denying that omicron will affect markets, it clearly already has had some affect since it began to make headlines. Even though our financial markets are full of data and considered to be relatively efficient, investor fear and sentiment can play a major factor in global markets. If investors believe that this new variant will have affects similar to the initial covid-19 pandemic and shutdowns, then markets will see huge selloffs and drops in the future. Covid has shown it can be a huge factor of market risk, especially now that we have seen the massive social and economic effects it had when it first began. This knowledge can be both good or bad when considering this new variant’s effect on markets because even though investors are worried bout omicron, they know more about the effects a virus can have on the market and therefore be better prepared. However, investors also could now be even more wary of the effects of a new variant and see it as a cause to panic.

Only time will tell what will happen, and as we learn more about this new variant, investors’ sentiments will adapt and adjust accordingly. I believe there will quite a bit of volatility in the market for the remainder of the year as the Fed continues to ease the United States economy off its unsustainable monetary policy and as we learn more about this new omicron variant. Times of uncertainty can be extremely difficult for investors, the headlines and news can cause them to worry or doubt themselves, but it is important to remain as rational as possible as an investor especially in times of uncertainty like what we have seen over the past week.

Sources:

https://www.wsj.com/articles/global-stock-markets-dow-update-12-03-2021-11638521460