A man walks past a Lunar New Year decoration in Beijing on January 12. China’s reopening has provided a positive shock to the global economy. Photo: EPA-EFE
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Why markets should not get carried away by China’s reopening
Just as a full reopening of China’s economy is no panacea for the world’s ills, a soft landing could turn into a harder one if inflation remains a problem
The economic and financial environment remains exceptionally volatile, with investors continuing to be blindsided by shifts in policy – including positive ones
As the World Economic Forum’s annual jamboree returns to Davos during the winter for the first time in three years, there is plenty for the global elite to fret about. Whether it is Russia’s invasion of Ukraine, the fallout from the dramatic rise in interest rates, concerns about a global recession or the risk of further geopolitical shocks, there is no shortage of threats and challenges.
Yet, as delegates discuss the gloomy outlook, the mood in financial markets has improved markedly in the past several weeks. Many investors in both advanced economies and emerging markets are now bullish.
Global bonds are on course for their best performance in January in three decades, having suffered heavy losses last year. More surprisingly, markets in more vulnerable countries and regions, as well as riskier assets, are enjoying strong gains.
Stocks in the euro zone – which were at the sharp end of the commodity shock caused by the war in Ukraine – have had their best start to the year on record. Emerging-market governments, meanwhile, raised more than US$40 billion in the first half of January while investors are piling into junk-rated US debt.
Tellingly, the world’s best-performing bond market is the one that was widely viewed as uninvestable only a few months ago. Chinese US dollar-denominated junk-rated debt – which is issued almost exclusively by property developers – surged 6.5 per cent in the first two weeks of January, taking its gains over the past three months to 32 per cent, according to Bloomberg data.
While the sharp improvement in sentiment comes from several factors, the full reopening of China’s economy has come like a bolt from the blue. Although there is a heated debate over the impact of the dismantling of the zero-Covid policy, fears that a rebounding China will fuel inflationary forces hold less sway among investors than expectations that it will provide a fillip to a global economy at risk of falling into recession.
02:24
China records second-lowest economic growth figure in almost 50 years after Covid-ravaged 2022
China records second-lowest economic growth figure in almost 50 years after Covid-ravaged 2022
To be sure, there are significant concerns about Beijing’s failure to prepare for an exit wave of infections. Thera are also questions about the strength and timing of the consumption-driven rebound. Yet, from a sentiment standpoint, China’s reopening is just what investors were hoping for.
As JPMorgan noted in a report published on January 11, the policy reversal is “a key component of the ‘soft landing’ scenario”, the view that leading central banks can bring down inflation without triggering a full-blown recession.
While the timing of China’s reopening is a wild card, coming just when inflation appears to have peaked and central banks are expected to slow the pace of monetary tightening, the end of the zero-Covid regime adds to a list of positive surprises in the global economy in the past few months.
Given the severity and scale of the sell-off last year and considering how bleak things looked as recently as October, investors have understandably latched on to these encouraging developments.
One of the most unexpected ones has been the plunge in European wholesale natural gas prices, mainly because of warm winter weather. This has improved the outlook for the euro zone. China’s reopening has turbocharged a rally in the bloc’s equity markets, giving Germany – whose largest companies are heavily dependent on the Chinese market – the biggest boost.
Since the end of October, German stocks have recovered practically all their losses suffered since late March 2022. The euro, meanwhile, has gained a further 4.5 per cent against the US dollar, “suggesting that the China reopening story has been a factor in [boosting sentiment towards] European equities and the euro”, JPMorgan noted.
Still, it is unlikely that markets would hold such a favourable view of the rapid opening up of China’s economy if inflationary pressures were not easing. Make no mistake, the overriding factor driving asset prices is the recent decline in inflation – particularly in the United States – and the expectation that the worst of the monetary tightening is over.
07:32
BIS chief Carstens: High interest rates to stay even if a US recession might be 'avoided' in 2023
BIS chief Carstens: High interest rates to stay even if a US recession might be 'avoided' in 2023
Yet, just as a full reopening of China’s economy is no panacea for the world’s ills, a soft landing could turn into a harder one if the fall in inflation proves deceptive or if the global recovery fails to take hold. The economic and financial environment remains exceptionally volatile, with investors continuing to be blindsided by shifts in policy, including positive ones such as China’s reopening.
Given the repeated failures by central banks and markets to predict the path of inflation, the biggest risk this year is that policymakers jump the gun by halting their rate-raising campaigns only to be forced to resume raising borrowing costs because inflationary pressures pick up again. Since central banks, especially the US Federal Reserve, are acutely aware of this risk, it makes it more likely they will overtighten and cause a recession.
China’s sudden reopening is a positive shock to the global economy. The next surprise, however, could have the opposite effect.
