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Delta variant fears infect markets but symptoms may be short-lived

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Delta variant fears infect markets but symptoms may be short-lived

Overlooked for weeks by investors, the risk that the coronavirus delta variant could disrupt the post-pandemic economic recovery has contributed to a sharp decline in stocks, a surge in demand for government bonds and a U.S. dollar rally.

The impact of the variant on markets, however, may be short-lived, analysts said.

"Bottom line, this is more a factor of some mildly negative headlines hitting a richly valued and somewhat complacent market, amidst the doldrums of summer," said Tom Essaye, a trader and founder of financial research firm The Sevens Report. "For this to cause a real correction, we'd need to see wide-scale restrictions or, worse, the Delta variant breakthrough a vaccine."

Over the course of just a few days, stock indexes have fallen from recent highs. The S&P 500 was down more than 2% on July 19 from its July 16 close and about 3.4% lower than its last record-high close on July 12. The decline, coupled with fears of the delta variant's impact, also eroded Treasury yields to their lowest point since February, spiked a key indicator of market volatility and sent fearful investors into haven currencies, including the U.S. dollar.

Delta, a highly contagious strain, is now the dominant strain in the U.S. and has led to some reimposed restrictions, including mask mandates in California and Las Vegas, quarantine restrictions in the U.K. and shutdowns in Australia. The U.S. recorded 79,310 new COVID-19 cases July 16, reflecting the highest daily total since April, according to data from Johns Hopkins University.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

The spread of the strain had little perceived impact on markets as stocks reached new record highs earlier in July. Economists with Goldman Sachs said in a July 13 note that the economic impact of the variant would be "modest" due to widespread vaccinations, particularly among elderly populations and data showing little change in consumer activity as virus cases and deaths have risen.

"As glib as this may sound, so many things with the markets are like this," said Paul Schatz, president of investment management firm Heritage Capital. "It doesn't matter until it matters and then it really matters. [COVID-19] was around for several months, but the stock market kept marching to new highs. And then it really mattered."

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As new COVID-19 cases have surged, the S&P 500 declined in three straight sessions through July 19. The Dow Jones Industrial Average and Nasdaq Composite Index were down as much as 2.7% and 1.7%, respectively, on July 19 from their July 16 closes.

"The equity market was looking for a reason to break and COVID jitters are the straw that broke this record-setting stock market's back," said Edward Moya, a senior market analyst with OANDA. "U.S. stocks were ripe for a pullback considering investors were complaining of how much froth was in the system and since they are seeing both peak earnings growth and monetary support."

Moya said U.S. stocks might tumble another 5% on "panic selling," but the dip will likely be bought up by investors.

"Wall Street still sees strong growth prospects over the next couple of years given the low interest rate environment," Moya said.

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Meanwhile, the benchmark U.S. Treasury 10-year bond yield fell below 1.18% on July 19, down 12 basis points from its July 16 settlement, the lowest yield since Feb. 11. Bond yields move inversely to bond prices, and the dropoff in yields suggests investors shifted to Treasurys as stocks declined, pushing prices up and yields down.

"Unfortunately, the bond market seems to continue to be sniffing out fear and a global slowdown," said Andrew Brenner, head of international fixed income at National Alliance Securities, in a July 19 note.

Wall Street's "fear gauge" is also starting to reflect investors' worries over the delta variant. The Chicago Board Options Exchange Volatility Index was trading as high as 24.93 on July 19, up about 35% from July 16 and the highest the index has reached since May 12. The index is a measure of stock market volatility expectations based on S&P 500 index options.

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The broad pullback in markets, tied to fears of a slowdown in the global recovery, has driven investors to safer bets in currencies, particularly the U.S. dollar. The Dow Jones FXCM Dollar Index on July 19 jumped to its highest level since November 2020.

The index measures the U.S. dollar against a basket of four currencies — the euro, British pound, Japanese yen and Australian dollar

A "bout of pandemic fatigue" likely contributed to this jump in market fear, said Oren Klachkin, lead U.S. economist with Oxford Economics.

"With case growth ticking higher again and some signs that vaccines won't be as effective at protecting against the Delta variant, investors have potentially been forced to recalibrate their expectations," Klachkin said.

But Schatz with Heritage Capital said the drop in equities and bond yields would likely be temporary, with markets "looking for an excuse to pull back," from all-time highs.

"I do not believe this is going to be a huge decline," Schatz said.