China protests and the long- and short-term market implications

The market is digesting the news that protests against China’s strict Covid zero policy have spread throughout the country. The major cities of Beijing and Shanghai have all experienced people taking to the streets, and, most unusually, criticism of Premier Xi Jinping. Already in his third term as leader, he has stated that he intends to be China’s leader for life, yet he has never experienced dissent on this scale. The pictures that are emerging from China bring back memories from the Tiananmen Square protests in 1989, which were crushed by China’s Communist rulers. There is a decidedly risk off tone to the market today and stocks are lower across the world. The S&P 500 has opened lower at the start of the week and is currently hovering around the 4,000 level as we wait for important economic data and a speech from chair of the Federal Reserve, Jay Powell, later this week.  

Anti-covid protests in China and the market impact

The key event is events in China. As we mention at the start, this has caused risk sentiment to weaken, and volatility to spike, the Vix index is up more than 7% so far, as the situation in China gets priced into markets. The protests in China impact the markets in two ways. Investors need to decide if this will speed up or slow down the prospect of China reopening? If China’s rulers follow the playbook from the Tiananmen Square protests, then they may crush the protest by force, however, they can’t deny that 3 years after the Covid pandemic started, China is still in the throes of the virus while the rest of the world has returned to normal. Already Chinese authorities have tightened controls on the public and dispatched thousands of police to prevent fresh protests from erupting. Added to this, state owned media continues to support the premier. Police have also been seen on the streets in Hong Kong, where small protests have formed in solidarity with the mainland. Thus, with covid infection rates soaring and still no imports of foreign-made MRNA vaccines, it is hard to see how Beijing will be able to control this latest outbreak.

The end of the China reopening trade?

The other question that investors need to understand is will these protests derail the Chinese reopening trade that was a major theme in financial markets in recent weeks, and led to large gains for Chinese stocks and stocks in the North Asian region? If yes, then the market could be forced to rethink some key trading strategies as we move into 2023.

The long-term impact for China PLC

Ultimately, the Communist party may quell the protests before bowing to the peoples’ message and reducing or scrapping draconian covid lockdowns to save face and make it look like the end of covid zero was their idea. However, the outlook for China is unclear, as is the potential diplomatic repercussions if China uses force against its own populace. This could impact markets and the global economy in two ways, 1, limit the upside for Chinese shares and 2, hasten the transition away from China as a major manufacturing production base. Chinese companies are also trying to look for offshore production sites, thus China’s economy could be structurally affected by the zero covid rules, with yet unquantifiable consequences for growth in the second largest economy in the world. Hence the risk-off tone to financial markets as we start a new week.

Explaining the resilience of the euro and the pound

Elsewhere, the President of the ECB, Christine Lagarde, said that the ECB is not yet finished with hiking interest rates even though producer prices have fallen sharply in Germany and there are other signs that inflation may be starting to peak. Lagarde told MEPs in Brussels that inflation in the Eurozone has not peaked, and that the ECB still has more work to do when it comes to stopping the stimulation of demand. Lagarde also poured hot water on the theory that lower wholesale gas prices, which have fallen sharply in recent months, would weaken CPI, and she said that there will still be some pass through of higher energy prices for months to come. This is one of the reasons why the euro has remained stable at the start of the week, even though stock markets and commodity prices have been spooked by events in China. The resilience of the euro and the pound in the face of Chinese turmoil, suggests that the trend for a weaker dollar could be here to stay. We will wait to hear from the Fed’s Powell and payrolls on Friday to determine the strength of the US labour market and what the Fed is thinking in terms of shrinking the size of its rate hike in December. But, if Powell follows the path laid by other Fed members and hints that a 50bp hike is on the cards next month, then the dollar may continue to weaken and stocks could catch a bid, if there is no further escalation in the China story.

Why the oil price is falling

Finally, a word on the oil price. Brent crude fell sharply on Monday and was down some 3% at the start of the week. Just a couple of weeks ago, Brent was trading just under $100 per barrel, it dipped to as low as $80 at one stage on Monday, before clawing back some losses to close the European session at just under $84 per barrel. This is the lowest level since late December 2021. The oil market has been battered by recession fears and now the threat of that there will be some disruption to the bullish China reopening trade. However, it is worth noting that there is plenty of upside risks for the oil price right now, including a cold winter and reduced Russian oil supply and the threat that price caps will cause Russia to halt production. Thus, even though the oil price is at an 11-month low, risks remain to the upside and a recovery could be on the cards. It could also hit the FX market, with a sizeable terms of trade risk, especially for those countries who are net energy importers.

To conclude

As we move towards the end of November, investor confidence has taken another knock due to political events in China. Will this impact China’s zero covid strategy, what will be the impact on growth and on geopolitical tensions? These are knowing unknowns that will need to be priced into financial markets, thus sentiment could remain shaky for the short term.