How China’s zero-Covid strategy helps US dollar strength but hurts Asian currencies

Financial markets are not oblivious to the implications of the global advance of the Omicron variant of Covid-19. Indeed, general unease about its spread could well have contributed to the US dollar’s steady end-of-year performance on foreign exchanges.

Omicron’s spread could also allow the dollar to retain its poise in early 2022, particularly against some Asian currencies. Its value against the Chinese yuan, the South Korean won and the Thai baht are cases in point.

Data from the US Commerce Department on December 29 showed a record US goods trade deficit of US$97.8 billion for November, well above October’s US$83.2 billion.

Meanwhile, on December 30, China’s State Administration for Foreign Exchange revealed its international trade data. It said that, in November, overall “receipts and payments from trade in goods were US$309.4 billion and US$259.3 billion respectively, resulting in a surplus of US$50.1 billion”.

If foreign exchanges had wanted to sell the US dollar versus the yuan, this data would have provided ample pretext to do so. As it was, though, currency markets adopted a “nothing to see here” stance and moved on.

It has been many decades since US trade data was the key monthly statistical release for currency markets. Even so, the absence last week of any reaction to an eye-wateringly high US trade deficit was arguably still revealing.

With regard to the exchange rate with the yuan, the US dollar held its own in the final weeks of December. Perhaps foreign exchanges have concluded that market circumstances favour the dollar, with policymakers in Beijing and Washington taking sharply contrasting approaches to managing the pandemic and the Federal Reserve and the People’s Bank of China now having divergent monetary policy trajectories.

Beijing continues to pursue a zero-Covid approach. Strict lockdowns are being imposed whenever new cases are detected, a strategy again in evidence in Xian.

While this policy remains in place, the PBOC will surely be obliged to continue providing monetary policy support to mitigate the impact of lockdowns on businesses and consumers. But if yields in China are heading down, the opposite looks to be the case in the US.

Living with zero Covid in China, 2 years and counting

With American officials perhaps concluding that Covid-19 is now endemic and cannot be eradicated, health policy is clearly moving towards a strategy of living with the virus and seeking to keep the US economy open. At the same, the Biden administration is pursuing fiscal stimulus to boost economic activity.

With undeniable evidence of higher consumer price inflation in the US, that leaves the Fed in a totally different position than the PBOC. While China’s central bank remains in easing mode, markets fully expect the Fed to tighten US monetary policy settings in the coming year.

From a market perspective, this could justify some degree of US dollar strength over the yuan in early 2022. But this strength should extend beyond the dollar-yuan exchange rate, given that the fortunes of many economies in Asia, and by extension their currencies, are inextricably linked to what happens in China.

The reality is that China’s zero-Covid approach has spillover effects for other Asian economies. South Korea’s won weakened by more than 9 per cent versus the US dollar last year.

This depreciation was driven in part by market recognition that pandemic-related supply chain disruption in China has a knock-on effect on South Korea, whose economy has close ties to China’s. This point was illustrated again last week by the impact of the Xian lockdown on production in South Korean technology giant Samsung Electronics’ factories there.

Pandemic-related restrictions on Chinese citizens travelling abroad have also had a big impact on the Thai tourism industry, a key sector in the nation’s economy. The Thai baht depreciated by more than 11 per cent versus the US dollar last year – its worst performance since 2000 – as markets priced in the economic hit from the collapse in tourism revenue.

The emergence of Omicron and China’s zero-Covid strategy, with accompanying monetary policy support from the PBOC even as the Fed is in tightening mode, is arguably underpinning the US dollar’s value versus the yuan.

At the same time, the spillover effects of China’s zero-Covid approach in 2021 have fed weakness in currencies like the baht and won. This situation might continue for a while longer with US dollar strength persisting into early 2022.

Neal Kimberley is a commentator on macroeconomics and financial markets