Quick takes on capital markets

22 Apr 2022

China markets: A policy predicament

Recently, China’s COVID-19 situation has deteriorated, with rising case counts and increasing lockdowns. While the People’s Bank of China has tried to limit capital outflows, their monetary response to the economic weakness has underwhelmed. Without concrete steps toward monetary easing or meaningful public health improvements, Chinese stocks will remain challenged.

China monthly new COVID-19 cases and Stringency Index
Level, January 31, 2020 – present

Stringency Index as it relates to China's Covid-19 cases between January 2020 to the present
Source: Bloomberg, Principal Global Investors. Stringency indices record the strictness of lockdown style policies that primarily restrict people’s behavior. Data as of April 21, 2022.

China’s recent COVID-19 outbreak has rendered the country’s “zero-COVID policy” extremely costly. With monthly cases on track to surpass the March 2020 peak, China has re-introduced strict lockdowns—a vastly different approach to most developed economies. High frequency economic data suggest that not only has China’s tough approach cratered domestic demand, it has also severely disrupted supply chains and countrywide logistics.

The People’s Bank of China (PBOC) efforts to tackle these economic headwinds have underwhelmed. The reserve requirement ratio has been cut by only 25bps, and benchmark lending rates have been left unchanged, frustrating hopes for more proactive policy easing.

Market dynamics suggest policymakers will remain cautious. With United States 10-year Treasury yields approaching 3%, the yield advantage of China’s government bonds over U.S. Treasurys has been eradicated, exacerbating capital outflows. Additional cuts in China’s key lending rates would only serve to further encourage outflows, limiting options. The PBOC’s struggle reflects the broader predicament Chinese policymakers are facing amid a challenging external environment—how to find balance between contradictive policy goals of zero-COVID and a 5.5% economic growth target.

Without concrete steps toward easing or meaningful improvement in the COVID situation, Chinese stocks may remain a sideways market in the near term—an environment that values managers with strong stock selection ability.

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