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OMG, Omicron! and the Effects on the Coffee Market

Today Fed Chairman Powell gave testimony before the US Senate where he cautioned on the economic impact of the #Omicron Variant on the US economy. This follows on the heels of the World Health Organization’s announcement on Friday that the new variant was a “cause for concern”. In this article, we discuss what the omicron variant is and what we can expect the impact to be on the macroeconomic environment and the coffee market.




Background

The omicron variant of the novel #coronavirus was first reported in South Africa to the #WHO on Nov 24th, and only 2 days later the WHO had already designated it a “concern”. The reason that it is a concern is because the variant has a large variety of mutations that could potentially bypass the immune system defenses, even those bolstered by vaccines. Research is currently being conducted to see if this will affect transmissibility and vaccine resistance.


The good news is that the symptoms appear to be relatively mild. However, as South Africa has a young population, this could be more to do with a healthy population rather than a uniquely mild virus.


President Biden has declared the variant a “cause for concern, but not panic.” This supports my opinion that there is little political will to reinstate any kind of large scale economic lock-downs. Though of course, that can change if we experience drastic increases in transmission or deaths.


Effect on the Global Economy

The biggest threat to the global economy from this new variant is the impact on #Monetary policy. #FederalReserve Chairman Powell commented on this before the US Senate today and his comments show a substantial degree of concern. He wrote,


"The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people's willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions."


In the rest of his remarks, Powell tried to strike a balance between stating that they would use all tools to support the economy and fighting #inflation.



These two are generally considered to be mutually exclusive. Supporting the economy means loose monetary policy, and fighting inflation means tight monetary policy. In the current environment we are already about as loose a policy as we can get and had been moving toward a tighter policy. This is known as “#tapering” which means expanding the money supply less rapidly.


The #USD market had generally been rallying in anticipation of this tightening in the monetary supply and the fact that this is now potentially threatened by the omicron variant has caused some volatility in the $DXY and potentially threatens the uptrend.


I think the US policy would likely be a microcosm of central bank policies around the world in this case. The US dollar is typically the strongest influence on other currencies and if the US is weakening their currency to support their economy, other countries may feel obligated to follow suit.


The exception may be in developing countries where inflation is already an even bigger problem. In #Brazil for example, the #BRL has struggled to gain against the USD despite a very attractive interest rate and a much tighter monetary policy. If their economy comes under threat from a new variant it could be a real problem, but it seems unlikely that the Brazilian Central Bank (BCB) would be able to just turn on the Quantitative Easing (QE) when they are already struggling to control inflation.


Effect on the Coffee Market

There are two main areas of concern for the coffee market with regards to the omicron variant.


The first comes from currency.


The global commodity market has been rallying strongly for the last year due to strong #demand, #supply chain crunches, and perhaps most importantly loose monetary policy. It is hard to separate exactly where inflation begins and monetary policy ends but the net effect is for a rallying #commoditymarket and weakening dollar.




This changed with the anticipation of tapering and the rallying USD that we have seen since the beginning of June 2021. This stronger USD has really knocked down some of the commodity indices with the notable exception of coffee. This is not to say that the stronger USD wasn’t a negative for coffee, but just that in this instance the current bullish fundamentals have likely overpowered it.


However, if the USD market turns around and moves lower that would generally be supportive of commodities and could be a source of strength for the coffee market. It is tough to say definitively though, as the strong rally from frost and drought is creating both upside and downside volatility that has little to do with current macroeconomic environment.




The second influence for coffee comes from the demand side.


If the Omicron variant actually does indicate that new lock-downs are required and the economy to tighten up, it could pose a threat to demand growth that would have been seeing a recovery from the reintroduction and reopening of weddings, tradeshows and restaurants. Again, I think this scenario is unlikely, but I often say that it is the market’s job to price in risks.


Right now, there is a risk of increased lock-downs and reduced economic activity. In March of 2020, the coffee market responded to the covid pandemic by selling off on reduced expectations of demand. We could see a similar sell-off in coffee if this latest variant gains traction in the public eye.

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