Residents line up for Covid-19 tests in Beijing on November 21. Daily cases have surged in China and frequent testing has resumed, soon after the government relaxed quarantine requirements for close contacts and overseas travellers on November 11. Photo: AP
by Nicholas Spiro
by Nicholas Spiro

In 2023, investors must manage expectations of a Fed pivot and China’s reopening

  • Investors desperate for good news are all too ready to entertain the possibility that US inflation has peaked and the Chinese economy is reopening
  • Instead of overplaying policy tweaks, they ought to focus on the underlying issues that will determine whether the hoped-for shifts materialise

Reports and presentations on the global economic and market outlook for the year ahead are rolling in. While the level of uncertainty has not been this high in decades, mainly because of what the International Monetary Fund rightly describes as “a unique mix of headwinds”, the forecasts come at a time of increasing optimism among investors.

While the FTSE All-World Index, a gauge of global stocks, is down more than 17 per cent this year, it is up 13 per cent since October 12. The sudden improvement in sentiment stems from signs of a long-yearned-for shift in the two most important policies affecting economic conditions and asset prices: America’s fight against inflation and China’s battle against the Covid-19 pandemic.

Although the signs are tentative, open to interpretation and too uncertain to qualify as a catalyst for a broad-based and durable rally, they are sufficiently important for investors – who are desperate for good news and easily influenced by the slightest hint of policy easing – to entertain the possibility that inflation has peaked and that China is preparing to reopen its economy.

As 2022 draws to a close, hints from Chinese and US policymakers are moving markets to an exceptional – indeed excessive – degree. Beijing’s decision to ease some of the restrictions underpinning its “dynamic zero-Covid” policy and the Federal Reserve’s signal that the pace of interest rate hikes is likely to slow are the dominant themes in markets.

Since both factors will have a profound impact on economic conditions and asset prices next year, investors would be well advised not to overplay tweaks in policy and instead focus on the underlying issues that will determine whether the hoped-for shifts materialise.

Beijing’s announcement on November 11 that it will ease some of its draconian pandemic controls has had a more dramatic effect on sentiment, one that has already begun to wane.


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No sooner did the government relax quarantine requirements for close contacts and overseas travellers than a surge in the number of daily cases to a near record high forced it to revert to its old playbook of strict curbs on people’s movements and frequent testing, sowing confusion over how it intends to manage the pandemic without enforcing the zero-Covid policy stringently.

Yet, Beijing never signalled that it planned to reopen the economy. Its objective is to try to avoid further Shanghai-style citywide lockdowns. The problem is that the transition from sweeping shutdowns and mass testing to even a partial reopening is fraught with risk.

Rather than reading too much into supposed shifts in policy, investors should instead focus on the efficacy of steps to prepare the ground for a reopening. The most important ones are a change in the political rhetoric around the virus, ramping up the vaccination drive and relieving pressure on the country’s poorly equipped healthcare system by allowing people with asymptomatic and less severe cases to isolate at home.

It’s time for China to change its Covid-19 narrative

The acid test of China’s willingness and ability to reopen is whether Beijing’s propaganda machine starts to meaningfully downplay the health risks of contracting the virus for those who are fully vaccinated. Just as importantly, there needs to be a sharp increase in the share of older people – particularly the over-80s – who have been fully inoculated. Based on these two measures, China is not even close to reopening.
Markets have also overreacted to signs the Fed is about to slow the pace of rate increases. A pivot towards less aggressive tightening looks more likely after a fall in America’s inflation rate last month, and the strong likelihood that prices will decline further next year due to sharp falls in commodity prices and an easing in pandemic-related disruptions.

Yet, again, investors are finding it hard to see the wood for the trees. While headline inflation is coming down, underlying inflationary pressures – especially wages which are growing at an annual rate of more than 5 per cent – are far too strong for the Fed to relent. Not only will rates need to rise to a higher level than anticipated, they will need to stay there for a longer period.

It is not the pace of tightening that matters, but how much damage – domestically and globally – is likely to be caused before the Fed is forced to start cutting rates. In a report published on Monday, JPMorgan said: “Catalysts for a proper pivot (cutting rates) are likely some combination of increased unemployment, declining inflation, and something breaking in financial markets.”

Global economy’s woes have world leaders burying their heads in the sand

This means investors should be careful what they wish for. Not only is a recession likely to be the key factor that brings the Fed’s rate-hiking cycle to an end, it is not even clear whether a sharp downturn will be enough to bring inflation back down to target. In China, meanwhile, even a partial reopening, if badly planned and poorly executed, could result in a devastating outbreak.

For governments and central banks, one of the biggest challenges next year will be managing expectations. For markets, resisting overinterpreting shifts in policy that are misleading is likely to prove even harder.

Nicholas Spiro is a partner at Lauressa Advisory