Markets always crave a good story, and the relaxation of China’s Covid-zero policy, with the prospect of a resumption of sustained growth, already has an excellent chance of being next year’s loudest narrative.
New and broad relaxations, which were outlined by China’s State Council on Wednesday (7) and include the possibility of home quarantine and the elimination of testing requirements for attending public places, added to the image of a country on the verge of two profound changes – one psychological, the other practical. US and European markets, note commodity traders, may have underestimated how the size of these changes will affect prices and inflation.
The MSCI China index, which rose nearly 19% in dollar terms last month, has begun to price in the possibility of China reopening from mid-November. In what its analysts described as a “big deal”, Morgan Stanley this week upgraded China to “overweight” for the first time in two years.
There are still a number of caveats to the reopening story, and even optimists think that a version of normalcy won’t resume until next spring. But broad optimism, despite all the potential for disruption, came quickly along with a cautious faith that momentum is in place.
Some strategists, acknowledging the risk that the easing will be uneven and punctuated by setbacks, suggest buying these dips when they occur. The big question is how much of the revaluation process has seeped into global markets and to what extent the reopening story will reverberate across them as it unfolds.
In a note published late last week, Goldman Sachs strategist Dominic Wilson attempts to answer those questions, noting that the bank’s core economic forecast was that Chinese growth could remain very weak over the next six months, before accelerating towards the end. from 2023.
Goldman’s approach relies on an index produced by the bank itself that tracks how general markets are pricing future growth in China. Since the beginning of 2022, this index has gone through three short upswings, but has fallen sharply overall. That decline has been consistent, Wilson said, with expectations for Chinese growth over the next one to two years steadily falling in major asset markets.
The hole, on October 31, was then taken as a base. According to the Goldman index, market expectations of China’s growth started to rebound strongly in November and remain high now. Given Wednesday’s news, they could increase even more strongly in the coming days.
Wilson’s conclusion on the scale of the market’s shift in growth expectations so far is that: “Renewed optimism around reopening in November implies that around 40% of that shift has already occurred.”
That number — and other similar indicators that could be produced by rival banks by the end of the year — seems highly significant, but should be treated with caution. The implied potential upside for the various asset classes affected by China’s growth differs widely. Goldman’s perhaps unsurprising view is that Chinese and emerging market equities are among the beneficiaries with the greatest upside potential. Copper and oil prices are in the same range. The Australian dollar could also be heavily affected.
But other markets may experience less positive effects: an accelerated expansion of Chinese growth could, in theory, produce an amplified impact on commodity prices, with knock-on effects.
European markets, for all the turmoil and sadness of high energy prices, have benefited to some extent from the fact that weak Chinese demand for gas has allowed supplies to be redirected. Accelerated Chinese growth could renew supply constraints and intensify inflationary pressure. If inflationary pressures become widespread enough, current market assumptions about a pause in the US interest rate hike cycle could be on the way to being revised.
Arguably, the most striking feature of the impact of China’s reopening on the market, however, is perhaps the speed with which it occurs.
Market participants saw a wide range of reopening processes around the world – from countries that rolled back extremely strict lockdowns to others that only imposed soft restrictions.
Markets may decide, as a result, that they don’t need to assess the reopening path in China as cautiously as elsewhere, and will simply look at growth forecasts for the end of next year and decide there is too much cost in delay.
Translated by Luiz Roberto M. Gonçalves
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