- The bullish reaction to China’s easing Covid measures last week was misplaced.
- China has not relaxed its zero-Covid at all, it has merely made some minor adjustments.
- A slowdown in Chinese crude demand could be a positive development for the fuel import bill of developed economies.
The bullish reaction in several of the world’s leading stock markets on the news that China has ‘relaxed’ its economy-crimping ‘zero-Covid’ policy was misplaced from all perspectives. Broadly, first, China has not relaxed its zero-Covid at all, it has merely made some minor adjustments. Second, these minor adjustments will make the net effect of its zero-Covid policy worse, as it will lead to a rise in Covid-19 cases, given the complete absence in China of any effective vaccination for, or treatment of, the disease. Third, it is China’s continued economic slowdown and not its economic buoyancy that should be welcomed by the world’s developed market economies. Such a slowdown will reduce China’s huge demand for oil and gas and it has been the skyrocketing price of energy that has led to the toxic combination of high inflation and high interest rates that threatens recession across several leading world economies. China’s zero-Covid policy is predicated on the imposition of ultra-tight lockdowns introduced across entire cities immediately that a relatively minuscule number of Covid-19 cases are identified. On 11 November, the Chinese government unveiled 20 minor changes to the zero-Covid policy that has been in place for around three years. One such change is that travellers from abroad will require one negative PCR test within 48 hours of boarding a flight to China instead of two. Another is that foreign travellers will have to quarantine for eight days, rather than 10, and another is that inside China people considered ‘close contacts of close contacts’ of Covid-19 carriers will no longer need to quarantine. The new guidelines also forbid mass testing unless ‘it is unclear how infections are spreading’ in an area. This said, the same day that these announcements were made, municipal officials in Beijing were requiring many of the city’s residents to be tested daily, more often than in recent weeks.
The core problem in China’s latest approach to Covid-19 is the same as with most half-measures: that is, they only serve to make the problem worse. In this example, any relaxing of China’s zero-Covid policy will lead to a marked increase in Covid-19 cases because the country still does not an effective vaccine against the disease or any variant thereof. This is despite ongoing offers from all major vaccine-producing countries to make such supplies available to it. Chinese President Xi Jinping has personally championed his country’s unilateral approach to fighting Covid-19, repeatedly characterising it in nationalistic and Chinese Communist Party terms. “We must adhere to scientific precision, to dynamic zero-Covid…Persistence is victory,” he said in April. “Zero-Covid is a people’s war to stop the spread of the virus,” he added. Additionally, this increase in cases will lead to more deaths, as China also does not have an effective post-infection anti-viral, and it still refuses to buy such supplies from foreign suppliers, again despite ongoing offers from several Western countries to make such anti-virals and post-infection treatments available to China.
The clean sweep of support that President Xi secured at the recent 20th Party Congress to be re-elected as General Secretary of the Chinese Communist Party for a third term almost certainly means that China’s approach to Covid-19 will not change meaningfully any time soon. “China’s commitment to its dynamic clearing COVID strategy remains the strongest headwind to growth, and official statements before and during the Party Congress trumpeted the policy as the most appropriate for the country,” Eugenia Fabon Victorino, head of Asia Strategy for SEB, told OilPrice.com. “In 2020, China’s economy managed a swift recovery from the first wave of infections as mobility restrictions succeeded in capping transmissions to a limited number of regions, but the increasingly contagious viral strains have led to a substantial rise in regions reporting daily new cases of Covid,” she added. Indeed, as of just over a month ago, even before the latest tweaks to China’s Covid-19 policy, 26 out of 31 regions had seen severe outbreaks. Moreover, at the end of last week, China’s National Health Commission reported 23,276 new daily Covid-19 infections.
In terms of specific negative ramifications for China’s economic growth, the key Purchasing Managers’ Index (PMI) for factory activity fell unexpectedly in October, to 49.2, a decrease of 0.9 from the previous month, and indicative of an outright contraction. In line with this, China’s crude oil imports for the first three quarters of the year fell 4.3 percent year on year to mark the first annual decline for the period since at least 2014. As at the end of the first half of this year, then, the economic outlook for China was already deteriorating more than had previously been expected, with SEB’s Victorino having already downgraded her GDP growth estimate for China earlier in the year, to just 3.5 percent.
A significant fall in oil prices may not be what oil producing companies want but it is certainly what the global economy needs, and particularly the economies of developed countries. Since the end of the third quarter of last year, global investors across all asset classes, including most notably commodities, have been eyeing a toxic combination of ballooning inflation powered largely by soaring energy costs, and repeated sharp increases in interest rates to combat this trend. At the same time, concerns have grown that higher-for-longer interest rates might tip developed market economies into recession. U.S. economic quarter-on-quarter growth fell from 3.7% in Q1 2022 to 1.8% in Q2 and the same again in Q3, as inflation rose to around 40-year highs of over 8 percent, and the Fed Funds rate was hiked to 3.75-4.00 percent. German economic growth saw the same pattern of decline, from 3.6 percent in Q1 to 1.7 percent in Q2 and to 1.2 percent in Q3, and so did the UK’s, from 10.9 percent in Q1 to 4.4 percent in Q2 and to 2.4 percent in Q3.
Why did this toxic inflation-interest rate-growth cocktail begin around the end of the third quarter of last year? It is principally because the end of September saw the public release of the first indications that Russia had specific plans for a full invasion of Ukraine. These were reports from several sources, based around the observations of U.S. intelligence officers of highly unusual Russian military movements on the Ukraine border after the conclusion of the joint Russia-Belarus military exercises that had taken place. This was the point at which savvy oil market players began to buy oil heavily. Before this, oil had been trading consistently around the US$65 per barrel of Brent level. This level reflected the equilibrium price that factored in the already evident weaker demand from China, which had surpassed the U.S. as the largest annual gross crude oil importer in the world in 2017 and had been the global backstop bid for oil since its rapid economic expansion began in the 1990s. As this Russia-Ukraine war premium declines as Europe continues to make arrangements to substitute energy from Russia with energy from other sources, as it will, this US$65 per barrel level is likely to be the base point for oil prices, up or down from then.
It is apposite to note that this level falls within the effective ‘Trump Oil Price Range’ of US$40-75 per barrel of Brent, as analysed in depth in my previous book on the global oil markets. Any price above US$35 per barrel is sufficient for the majority of U.S. shale oil producers to turn a decent profit. Any price above US$75 per barrel starts to increase fears in U.S. presidents of exactly the sort of toxic equation of rising energy prices driving rising inflation driving lower growth driving electoral disaster that have been seen since September last year.
By Simon Watkins for Oilprice.com
Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…