China's reopening post ‘zero-Covid’ lockdown

Fed Rate Hike Odds May Rise as China Roars to Life

By:Ilya Spivak

China has returned to rapid growth after scrapping ‘zero-Covid’ lockdowns, cheering the markets. The mood may sour however as reopening stokes inflation, beckoning action from the Fed.

  • Chinese economic activity is accelerating rapidly, according to PMI data
  • Investors cheer reopening after ‘zero-Covid’, but the mood might sour
  • Commodity price rise may boost inflation, demanding Fed rate hikes

China is accelerating after scrapping Covid-19 lockdowns

The world’s second-largest economy is finally showing signs of life after scrapping ultra-restrictive ‘zero-Covid’ virus containment policies in December 2022. The latest round of PMI figures – an official set from the China Federation of Logistics & Purchasing (CFLP) and a private-sector analog from S&P Global and Caixin – shows rapid pick-up in manufacturing- and service-sector growth.

These indicators are centered around “50”. Readings above this level mark expanding activity in the economic sector being tracked – either manufacturing or services – while values below it indicate contraction. The greater the distance from 50 in either direction, the faster the process underway. That puts growth at the fastest pace in at least 8 months (Caixin), and perhaps over 6 years (CFLP).

China PMI - Caixin
Data source: Bloomberg

Investors seem to have greeted the news with enthusiasm. The tell-tale Australian Dollar – a bellwether for the markets’ view on China because of its home country’s tight-knit trading links with the East Asian giant, as a well as a go-to reflection of market-wide risk appetite – rose gingerly when the PMI figures crossed the wires. The mood may sour as markets ponder the dark side of reopening however: inflation.

Reopening may drive up inflation, beckoning Fed action

Moderating price growth in the second half of 2022 has tellingly tracked a pullback in commodity prices. Some of this surely owes to the Fed’s blistering rate hike effort. It slowed economic growth, and inflation with it. A warmer winter that kept Europe from feeling the pinch of absent Russian natural gas supply helped as well. Still, a sharp drop in demand from China – the world’s top importer of most commodities – played a key part.

With the pace of economic activity growth accelerating, Chinese commodities demand seems likely to swell. If that overpowers demand destruction elsewhere – a seemingly strong possibility considering how much ground must be made up after lengthy lockdowns – prices are likely to rise. That will feed into another inflationary pickup, pushing the Fed toward a still-move hawkish stance. That may hurt stocks and gold prices, while the US Dollar gains.

Commodity price drop helps drive US disinflation
Data source: Bloomberg

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