A different reopening playbook for China

Quick read:

• After a strong six-month stretch, Chinese leading indicators have recently waned and look to be defying expectations that the removal of COVID lockdowns would result in broad-based reopening demand.
• We see few signs of domestic inflation pressures in the Chinese economic data and lackluster export data from China’s regional trading partners. This may be consistent with a relatively narrow, services-oriented reopening that will result in fewer economic spillovers to foreign markets and may require easier monetary policy in China going forward.
• In our tactical multi-asset portfolios like the BlackRock Tactical Opportunities Fund, we have long positions in Chinese onshore rates as we see low inflation as a catalyst for further monetary easing. Within equities, we are short regional trade partners like South Korea where weak Chinese import demand is likely to weigh on corporate earnings.

“Revenge spending,” “YOLO economy,” and “pent up demand” are a few phrases that were used to describe the US economy’s powerful and sustained demand acceleration in the two years following the pandemic. A similar dynamic of inflationary growth took hold in Europe after its COVID restrictions were lifted at the start of 2022. Therefore, it is not surprising that many market participants adopted a parallel reflationary playbook at the start 2023 related to China’s lifting of lockdown restrictions. However, recent leading indicators, inflation prints, and trade data suggest that the uplift in nominal activity catalyzed by the Chinese reopening may be less large and less durable than expected.

A narrow restart

The visual below shows our team’s proprietary China leading economic indicator. It utilizes machine learning to parse hundreds of data series ranging from property floor space sold to domestic airline miles travelled to try to identify turning points across different sectors of the Chinese economy. The magnitudes are all normalized to be relative to their trailing average, which allows us to compare the dynamics across different parts of the economy on a common footing. Though we can see a clear improvement in consumption and production indicators post-reopening, we see fewer signs of an uplift in the important real estate and capital goods sectors of the economy. With indications that the most recent April data have decelerated, some have begun to reassess the durability and breadth of the economic restart.

Chinese leading economic indicators have decelerated

There are many reasons that the Chinese restart might not be as large, inflationary, or sustained as those experienced in Western economies. First, the Chinese economy experienced broad-based strength in the initial years of the global pandemic, so there may have been less pent-up demand. Second, consumption makes up a much smaller share of Chinese activity (54%) compared with Western economies like the US (83%) or Germany (72%), so consumption and services spending have less of an ability to catalyze economywide growth.¹ Third, the policy responses to lockdowns in China were much more restrained compared to the powerful stimulus that was provided by Western central banks and fiscal programs.² A combination of these factors, along with continuing challenges for the property sector and high overall indebtedness are likely weighing on the restart.

No signs of an inflation pick-up

Despite differing health outturns, policy responses, and reopening sequences, the inflationary impulse of reopening across the major developed markets has been strikingly similar. A combination of supply side disruptions and excess consumer demand have resulted in persistent and sticky inflation accelerations. However, six months into the Chinese reopening, there are no clear signs of a parallel inflationary dynamic taking hold. 

The chart below shows how the lifting of COVID restrictions in the US, then in the Eurozone, and finally in Japan catalyzed a series of upward revisions to inflation estimates in each market. In contrast, inflation revisions in China have thus far been revised downward since the reopening announcement at the end of last year. China’s most recent CPI print for April was 0.1% year-on-year with few signs of price pressures across the basket items.

Chinese inflation has remained tepid following COVID-reopening

A drag for China’s trade partners

Muted price pressures within China stem from weak overall demand with an excess of production capacity. At an aggregate level, the weakness in Chinese demand can be proxied by a 10% decline in Chinese imports from December to April. This is likely to weigh on the corporate earnings in large, regional trading partners like South Korea, Japan, and Australia. Given the positive sentiment boost that some of these markets experienced since the reopening announcement, there is the potential for downward revisions to the outlook in the coming quarters.

Trade across China’s regional partners has fallen since the start of the year

What do these views mean for portfolio positioning?

In our tactical multi-asset portfolios like the BlackRock Tactical Opportunities Fund, we seek to deliver diversifying returns that are lowly correlated with stock and bond markets. We do so primarily by seeking out relative value opportunities across different countries in both stock and government bond markets.

Our insights on inflation across countries help to inform our fixed income positions. We have long positions in Chinese onshore rates as we see low inflation as a catalyst for further monetary easing. Within equities, we look for countries with attractive pricing and earnings outlooks. We are short regional trade partners like South Korea that have seen a positive sentiment bounce related to the China reopening but may disappoint on earnings if Chinese import demand is weaker than expected.