China’s zero-Covid policy realigns global economy and financial markets

In October 2020, China was hailed as the first major economy to emerge from the Covid-19 pandemic, recording quarterly growth seen as an endorsement of Beijing’s zero tolerance policy, or locking down cities and millions of people at the first sign of an outbreak.

How this narrative has changed.

China’s so-called zero Covid policy is now seen by some analysts as a disruptor to the global economy, rather than a driver of recovery, and is generating uncertainty for all financial markets, including cryptocurrencies. .

“China’s economy is clearly shrinking under the weight of zero-COVID policies,” according to a May 31 report by US think tank Rhodium Group, which specializes in researching the country’s economy, the world’s second-largest.

“Consensus expectations did not fully take into account the degree to which China’s economy has weakened this year, nor the likelihood that slower growth will continue in coming years,” the report, titled Rethinking Economics, said. economic future of China.

The 25 million people of Shanghai, one of the world’s major cities, emerged last week from a two-month Covid-19 lockdown that closed factories, offices and transport networks in the center Chinese financier and got people to form groups on social media to trade food. .

Truck no

An example of how China’s Covid-19 policies can cripple a city’s basic supply networks was explained by an official at milk delivery company Guangming Dairy in Shanghai.

“We were producing the milk, but we couldn’t deliver it to customers and we had to absorb the losses,” said the head of the subsidiary of China’s second largest food group Bright Food Group. Forkast May 31.

The milk delivery failure is a microcosm of the transportation disruptions that occur across China when a city or region is locked down under zero-Covid.

Domestic truck flows fell 27% in April from the same period last year, according to G7 Connect, which tracks truck shipments. Trucks carry around three-quarters of China’s total cargo, according to official data.

“The fact that they are still going to maintain this zero-Covid policy is still a big overhang in the markets,” said Andrew Sullivan, who spent 17 years trading stocks in Hong Kong, including at BNP Paribas.

pebble in the pond

The Shanghai shutdown has reverberated far beyond China, as companies such as Tesla Inc., Toyota Motor Corp. and Apple Inc. reported factory closures and broken supply chains.

The zero-Covid policy is generating new concerns about China’s economic future and its position in the global economy, according to the Rhodium report.

“Financial markets have reacted accordingly, selling off Chinese assets in large volumes, as companies reassess the importance of China in their global strategies,” the report said.

Sullivan notes that companies were already considering reorganizing supply chains due to US tariffs on China and that this will accelerate as Beijing is expected to pursue the zero-Covid policy.

Apple plans to move some of its assembly production to Vietnam from China, which could provide Vietnamese companies with opportunities to manufacture components, he said. That, in turn, would attract more Apple suppliers to the country, said Sullivan, who now writes commentary on Asian markets.

The rise of supply chains from China has added to inflationary pressures elsewhere in the world, with inflation hitting a 40-year high in the United States to around 8.5% per month this year.

US Federal Reserve Governor Christopher Waller said it was a combination of strong consumer demand and supply constraints when he spoke on May 30 at the Institute for Monetary and Financial Stability in Frankfurt, Germany.

“I support the policy of tightening an additional 50 basis points for several meetings. In particular, I will not take 50 basis point hikes off the table until I see inflation moving closer to our 2% target,” Waller said.

No chance

The threat of higher interest rates to tame inflation is dragging stock markets lower, with the Nasdaq posting a five-week losing streak in May, the longest since 2012.

Bitcoin investors have also been spooked by inflation – despite the asset’s reputation as an inflation hedge – with the cryptocurrency falling 40% from its peak in November last year .

But Tony Sycamore, financial markets analyst at Sydney-based City Index trading platform, says getting inflation back to 2% is a pipe dream.

“I can tell you categorically that there is no chance that inflation will approach 2%; not this year, not next year,” Sycamore said.

Meanwhile, April data from China shows industrial production, retail sales and fixed asset investment all fell to two-year lows.

The Rhodium report says these and other similar numbers indicate that China’s real GDP growth target of 5.5% this year is unattainable and the most likely growth is no more than 2%. , and that would hinge on a rebound in the second half.

And the absence of any lockdown the size of Shanghai.

Due to the sheer size of the Chinese economy, such a slowdown, while creating its own problems, could ease inflationary pressures around the world and, therefore, pressure on central banks to raise rates. of interest. This may provide some relief to stocks and, by extension, cryptocurrencies.

Ben Caselin, head of research at cryptocurrency exchange AAX, says Beijing has cracked down on the crypto industry and trade on the mainland, but that doesn’t mean China isn’t influencing the markets.

China’s plan for a central bank digital currency is something investors need to watch as it could act as a stimulus and is part of Beijing’s efforts to reduce US dollar risk – all interesting developments for China. gold and bitcoin, he said.

“While the US economy and its policies are closely tied to Bitcoin price discovery, too often China is left out of the analysis,” he said.