Further Covid lockdowns in China would be “another headache” for the Federal Reserve in its battle against inflation, experts say, although global supply chain bottlenecks are easing.
IIf there’s any indication that what happens next in China is a big deal for the US economy, it’s that Federal Reserve officials mentioned the country’s Covid-related lockdowns eight times at their last policy meeting on June 15.
President Jerome Powell and others have warned of several “downside risks,” including “larger-than-expected effects on economic growth” from external factors such as Russia’s invasion of Ukraine and , most recently the Covid-related lockdowns in China.
China’s “Zero-Covid” policy triggered near-total quarantines earlier this year in several major cities, including the busy port of Shanghai, in a bid to contain the spread of the Omicron variant. Now China has reported its first national cases of the highly contagious BA.5 subvariant, as global Covid cases rise at their fastest rate in nearly two months.
A second lockdown of Chinese manufacturing hubs, whether full or partial, would stall global supply chain recovery after more than two years of the pandemic and provide additional upward momentum to prices paid by industry and consumers in the United States, according to experts. Observers are divided on the severity of the headaches. Some say the disruption would prove to be just a blow to the US economic recovery, while others, including the Fed, say it could undo recent gains by returning to more normal functioning.
“The scenario playing out in China right now is obviously a risk – not just for China but also for the rest of the world,” said Tim Uy, economist at Moody’s Analytics.
Everything depends on the Chinese government’s response to the resurgence of the virus and its strict adherence to the Zero-Covid policy. Authorities have so far largely dismissed claims of new lockdowns, but the possibility has nonetheless already begun to rattle China’s stock market. Macau’s Chinese gaming center, which has seen more than 1,500 confirmed Covid infections since mid-June, said last week it was temporarily close its casinos for the first time in more than two years in an effort to stem the spread of the virus. The mecca of the casino is to forbid residents to leave their homes, except for essential activities. Meanwhile, the island’s casino operators, including Las Vegas Sands, MGM and Wynn, expect to make no income in the near future.
“The scenario playing out in China right now is obviously a risk – not only for China but also for the rest of the world.”
The impact of the shutdowns, which lasted through April and May, was felt by several major U.S. companies, including Apple and Tesla, which both faced supply chain issues in China. During Tesla’s second-quarter earnings call on Wednesday, billionaire CEO Elon Musk admitted he was “concerned about [the] the company’s overall liquidity” as it was “uncertain when the Covid lockdowns in China would ease”.
The broader Chinese economy has also suffered. The country’s GDP grew by just 0.4% in the second quarter, a sharp decline from the 4.8% growth rate in the first quarter, official data showed last week. Shanghai and Jilin, where there were complete lockdowns, saw their tax revenues fall 52% and 79%, respectively, from April to May compared to a year ago, according to analysts at Bank of America.
China appears to be walking a fine line between maintaining its Zero-Covid strategy while trying to limit the economic damage another widespread lockdown would cause. President Xi Jinping has doubled down on his policy in a address last month, saying it was the most “economical and efficient” way forward and that a change in Covid strategy would be “incredibly” bad. The Chinese leader insisted that a “dynamic Zero-Covid policy” is best for the country even if it “temporarily impacts economic growth”, which must always be maintained “as much as possible”.
The Chinese government, however, also remains attentive to public opinion. People in Shanghai, for example, “vehemently” do not want to experience a similar lockdown, according to Brendan Ahern, chief investment officer at China-focused ETF provider KraneShares.
“There is an argument that after Shanghai there was a bit of a shift in China’s response,” with a “tuning” of the Zero-Covid policy, Ahern says. He points to recent outbreaks in several cities where authorities have implemented more micro-level restrictions targeting neighborhoods or apartment complexes rather than an entire city. “The cost of the Shanghai lockdown has shown that there is a very significant economic consequence to having a comprehensive response,” he says.
Meanwhile, investors are worried about more foreclosures, says Adam Crisafulli, founder of market intelligence provider Vital Knowledge. While “the bar for wholesale closures is higher than before,” removing cases to zero is going to be “difficult” given the extreme contagion of new variants, he says.
China’s economic situation is confusing as data shows the lag effect of citywide lockdowns, Uy says. Most pundits had an optimistic outlook at the start of the year, but have since revised them down, he says.
What would this mean for the Fed’s continued efforts to bring inflation down? A “more complicated picture” and “another puzzle,” which will likely force the Fed to become more aggressive in setting policy rates, according to Stephen Juneau, senior U.S. economist for Bank of America’s global research team . “They can’t correct supply-side factors, but they can continue to put downward pressure on demand.”
Federal officials noted last month that lockdowns in China were “likely to exacerbate supply chain disruptions”, which in turn would “affect the outlook for inflation” negatively, according to the minutes of the June central bank meeting.
Analysts, however, point to the surge in exports seen in the latest trade data from China, which helped ease fears of a slowdown that would push commodity prices further and indicated that bottlenecks in the supply chain are diminishing. Port times in North America and Asia are down slightly, while data from the Federal Reserve Bank of New York suggests that the United States is seeing an improving balance between supply and demand, which which could contribute to moderating goods inflation.
“Even if China were to return to isolation, especially in major cities like Shanghai, it would be a bit of a blow to our current trajectory, but I don’t think it would derail this moderation in supply tensions,” Uy said.
Most experts predict a milder fallout than previous lockdowns, Uy says. They agree that it does not appear that hospitalizations and death rates in China are rising markedly in a way that would justify more citywide shutdowns. Given the negative economic impact of previous lockdowns, the Chinese government will likely pursue a more targeted approach, they say.
“I anticipate that even if there is another lockdown in Shanghai, the impact will be more moderate, as authorities are likely trying to keep as many businesses open as possible,” Uy says.