If there’s any indication that what happens next in China is a big deal for the U.S. economy, it’s that Federal Reserve officials mentioned the country’s Covid-related lockdowns eight times at their latest policy meeting on June 15.
Chair Jerome Powell and others warned of several “downside risks,” including “larger-than-expected effects on economic growth” from external factors such as Russia’s invasion of Ukraine, and more recently, Covid-related lockdowns in China.
China’s “Zero-Covid” policy triggered near-total quarantines earlier this year across several major cities, including the busy port of Shanghai, in an effort to contain the spread of the Omicron variant. Now China has reported its first domestic cases of the highly contagious BA.5 subvariant, while overall Covid cases are rising at their fastest pace in nearly two months.
A second wave of lockdowns in Chinese manufacturing centers, whether it’s full or partial, would stall the recovery of the global supply chain after more than two years of pandemic and give an additional upward push to prices paid by industry and consumers in the U.S., experts say. Observers are split on how severe the headaches would be. Some say the disruption would prove to be just a blip in America’s economic recovery, while others, including the Fed, say it could reverse recent gains in getting back to more normal functioning.
“The scenario that’s playing out in China right now is obviously a risk — not just for China but also the rest of the world,” says Tim Uy, an economist at Moody’s Analytics.
Much depends on the Chinese government’s response to the resurgence of the virus and whether it remains strictly committed to the Zero-Covid policy. Authorities have so far widely rejected claims of new lockdowns, but the possibility has nonetheless already begun to rattle China’s stock market. China’s gambling hub of Macau, which has seen more than 1,500 confirmed Covid infections since mid-June, said last week that it was temporarily closing its casinos for the first time in more than two years in an effort to stem the spread of the virus. The casino mecca is prohibiting residents from leaving their homes except for essential activities. Meanwhile, casino operators on the island, including Las Vegas Sands, MGM and Wynn, are expecting to make no revenue in the near future.
“The scenario that’s playing out in China right now is obviously a risk — not just for China but also the rest of the world.”
The impact of the lockdowns, 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. On Tesla’s second-quarter earnings call Wednesday, billionaire CEO Elon Musk admitted that he was “concerned about [the] overall liquidity of the company” as it was “uncertain as to when the Covid lockdowns in China would alleviate.”
“It’s kind of been supply-chain hell,” Musk said.
The wider Chinese economy 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, according to official data published last week. Shanghai and Jilin, where there were full lockdowns, saw their fiscal revenue slump by 52% and 79%, respectively, from April to May compared with a year ago, according to Bank of America analysts.
China appears to be walking a fine line between maintaining its Zero-Covid strategy while trying to limit the economic harm that another widespread containment would bring. President Xi Jinping doubled down on the policy in an address last month, saying that it was the most “economic and effective” way forward and that a shift in Covid strategy would be “unthinkably” bad. The Chinese leader insisted that a “dynamic Zero-Covid policy” is best for the country even if it temporarily “impacts economic growth,” which should still be maintained “as much as possible.”
The Chinese government, however, also remains attuned to public sentiment. People in Shanghai, for instance, “vehemently” do not want to go through a similar lockdown, according to Brendan Ahern, chief investment officer at China-focused ETF provider KraneShares.
“There’s an argument that post-Shanghai, there’s been a bit of a change in China’s response,” with a “tweaking” 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 showed that there’s a very significant economic consequence to having a blanket response,” he says.
Meanwhile, investors are anxious about more lockdowns, says Adam Crisafulli, founder of market intelligence provider Vital Knowledge. While the “bar for wholesale shutdowns is higher than before,” suppressing cases to zero is going to be “difficult” given the extreme contagion of the new variants, he says.
China’s economic picture is muddled as data show the lag effect of the citywide lockdowns, Uy says. Most experts had rosy outlooks at the beginning of the year but have since revised them significantly lower, he says.
What would this mean for the Fed’s ongoing efforts to bring down inflation? A “more complicated picture” and “another headache,” which will likely force the Fed to become more aggressive when setting policy rates, according to Stephen Juneau, senior U.S. economist for Bank of America’s global research team. “They can’t fix supply-side factors but they can continue to put downward pressure on demand.”
Investors are anxious about another potential wave of Covid lockdowns in China.
Fed officials indicated last month that the lockdowns in China were “likely to exacerbate supply-chain disruptions,” which in turn would “affect the inflation outlook” in a negative way, according to the minutes from the central bank’s June meeting.
Analysts, however, point to the surge in exports seen in the latest China trade data, which helped ease fears of a slowdown that would further drive up the prices of goods and indicated that supply-chain bottlenecks are easing. Port times in both North America and Asia are down slightly, while data from the Federal Reserve Bank of New York suggest that the U.S. is seeing an improved supply-and-demand balance, which could help moderate goods inflation.
“Even if China does go back into lockdown—particularly in big cities like Shanghai—it would be a bit of a blip in our current trajectory, but I don’t think it would derail this moderation of supply stresses,” Uy says.
Most experts predict more moderate fallout than the previous lockdowns, Uy says. They agree that it doesn’t seem like China’s hospitalizations and death rates are rising markedly in a way that would justify more citywide lockdowns. Given the negative economic impact of previous lockdown measures, the Chinese government will likely pursue a more targeted approach, they say.
“I anticipate even if there is another lockdown in Shanghai, the impact will be more moderate, as authorities likely try to keep as many businesses open as possible,” Uy says.