What China’s pivot from COVID-zero could mean for currencies
By the OFX team | 6 December 2022 | 5 minute read
News that China is easing COVID restrictions is rapidly changing the outlook for the global economy.
The world’s second largest economy has been in a form of semi-stasis for almost three years as it pursued a COVID-zero policy. Widespread snap lockdowns at the first sign of a breakout have not only rocked domestic economic activity but roiled global supply chains as the “world’s factory” effectively shut down.
Given the scale of China’s economy and the outsized role it plays in global demand, any signs that the policy is being loosened has a correspondingly large impact on financial instruments linked to China’s revival. If China continues with its tentative steps toward reopening, then expect a stronger year ahead for China-facing currencies — that is if the country can maintain its looser policy without facing a public health emergency.
Hopes that China could move away from its current COVID-zero policy have already benefited currencies correlated with Chinese economic growth
“While rising case numbers and new restrictions pose a threat to near-term growth, signs of a shift in outbreak management have boosted hopes authorities will abandon COVID-zero in Q2 2023,” says Matt Richardson, Senior Client Manager at OFX.
COVID-Zero rules easing as citizens take to the streets
From a health perspective China’s COVID-zero policy has worked, with a reported death toll of 5322, compared to 1.08 million in the United States.1
From an economic perspective it has been disastrous, with China’s economy growing by only 3.9% over the past year, compared with its target of 5.5% for 2022. Unemployment, especially among the young, is rising and property prices are falling.2
With nearly 530 million people — almost 40 percent of the population — under some form of lockdown in late November 20223, the toll of three years of restrictions has recently escalated among citizens.
Perhaps recognizing that continued restrictions would cause further discontent, the Chinese government has started to ease back on the strict COVID rules.
In major cities across the country, testing requirements for activities such as taking public transport were scrapped or scaled back, and the country’s chief health official in charge of the COVID response dialed down the rhetoric around the severity of the virus.
While rising case numbers and new restrictions pose a threat to near-term growth, signs of a shift in outbreak management have boosted hopes authorities will abandon COVID-zero in Q2 2023
Yuan leaps on prospect of a reopening
The prospect of lockdowns being eased put a rocket under currencies and stocks linked to Chinese growth. Against the US dollar, the yuan hit its highest level since mid-September on December 5, and then had its best week since 2005 as it climbed 1.6% in the week to Friday, December 2, although US dollar weakness also contributed to the surge.4
Major US investment banks have turned bullish on the Chinese economy based on the expectation of continued reopening, prompting the benchmark stock market index, the CSI300, to rise nearly 10% in November as nearly $US8.5 billion flooded into equities from cross-border flows5 (net inflows of money to buy equities in mainland Chinese companies help push up the value of the Chinese currency).
China-facing currencies also do well
According to OFX’s Richardson, “hopes that China could move away from its current COVID-zero policy have already benefited currencies correlated with Chinese economic growth.”
On December 5, for instance, Australia’s major mining companies shot up as much as nearly 7% on the prospect of a rise in the price of iron ore, while the Australian dollar hit its highest level since early September.6 The New Zealand dollar is also performing strongly, up 1.82% against the USD the five days up to December 5. As a significant exporter of agricultural commodities to China, its strength is also strongly correlated to a Chinese reopening.
Reopening will have global benefits
As the “world’s factory”, China’s lockdowns have had a deeply negative impact on global supply chains, pushing up prices as retailers are forced to carry more stock, or bid higher for limited stock of goods.
The Foxconn factory in Zhengzhou in central China, accounts for 50-60% of global iPhone assembly capacity. The factory’s closure in November prompted Apple to warn that there would be longer wait times and fewer shipments of the latest iPhone.7 Extrapolate that across China’s manufacturing ecosystem, and the global impact of rolling closures gives a hint of how disruptive lockdowns have been.
“A broad reopening of the Chinese economy will offer welcome relief to global supply chains and growth prospects,” says Richardson.
As economies continue to feel the pain of stubborn inflation, the reopening of China could help ease global inflationary pressures caused by supply chain issues. Cooling inflation would allow central banks to ease on the aggressive rate hikes that have been implemented to curb consumer spending and bring inflation under control. Changes in relative interest rates between countries will impact the demand for currencies as investors chase higher yields.
On the flip side, China’s restrictive travel rules have meant that demand for oil has been muted, while decreased factory output has curtailed electricity usage. A reopening may result in upward pressure on prices for energy commodities.
A clear commitment by Beijing to reopening would unleash three years of pent-up demand and supercharge Chinese growth
Relaxing restrictions may present challenges
While the Chinese government appears to be recognizing that the economic cost of COVID-zero is becoming unsustainable, relaxing restrictions in China could be a problem. There are concerns around current vaccination coverage and that China’s citizens may be more susceptible to an outbreak.
According to predictive health company Airfinity, if China were to lift strict restrictions now, between 160 million and 280 million people could be infected with potentially 1.3 million to 2.1 million deaths, largely among unvaccinated older adults. Demand for intensive-care beds could be more than 15 times the current capacity.8
China still hasn’t approved the use of foreign vaccines, which are more effective than the domestic vaccines, and the COVID-zero policy has meant many elderly citizens have not been rushing to obtain booster shots.9
If there is a wave of infections and deaths in the coming months, restrictions may be either reinstated, or as happened in the early days of mass infections elsewhere, citizens may self-quarantine to avoid getting sick.
What to watch
Policy pronouncements that show China will continue reopening will boost global risk sentiment. News that puts reopening at risk could see recent gains of riskier assets reversed.
A clear commitment by Beijing to reopening would unleash three years of pent-up demand and supercharge Chinese growth. It’s likely the government would add economic stimulus to lift output from the current 3.9% to the 5% GDP growth target set by the Chinese Politburo.
That would result in higher prices for commodities, benefiting commodity currencies like the Australian dollar and New Zealand dollar. It would also benefit the Chinese stock market, meaning a currency inflow into China from countries like the US, pushing up the value of the yuan.
All eyes will be on how China handles the likely wave of infections that will come with reduced restrictions. If the country can successfully roll out a widescale vaccination/booster program, the fatality rate may be something Beijing can tolerate.
The alternative scenario — high transmission and an overwhelmed health care system — could see more uncertainty globally and a heavy financial market selloff.