Will Unrest In China Spook Markets?

China has been hit by twin shocks. First of all the rate of COVID infections has spiked dramatically higher, pushing above levels seen at the last peak and this suggests that China following its very strict COVID policy we’ll have to lock down further and greater parts of its economy.

The second shock which many did not expect, is the reaction of ordinary Chinese to the COVID shutdowns. There have been riots and unrest reported across China and this is relatively unusual. It’s even more unusual that this unrest makes it into the media in the West – there is not yet a great deal of transparency as to what is happening in China. For example in one city the authorities have used jamming devices to stop social media broadcasting footage of unrest and recent deaths in a fire so we can only guess how bad the situation is.

Lockdown

From the point of view of markets and investors this could be the next shock. A further shutdown of China’s economy could push the world economy further into recession. Many investors will be aware of the initial shock of COVID on western markets in March over two years ago and they’ll also be aware that Chinese markets and Asian markets in general have rallied on hopes that China was going to reopen. These hopes have now been quashed.

There are different things to watch for from an investment point of view. One is the Chinese currency which has typically being held in place by Chinese policymakers. There may now be both the market pressure and the willingness by Chinese policymakers to allow their currency to weaken.

Another key metric for investors is the performance of commodities. In the last week the price of oil has fallen by over 12% , this has largely been due to weaker macro data in both the US and Europe. Yet, oil and other commodities notably copper and iron ore prices are key to watch as China begins to shut down in a more dramatic way

A third metric is the performance of large western companies with consumer and producer bases in China. The one most investors will look at is Apple which fell 2% on Friday. Apple is important here as a reading of the health of the Chinese economy, but also of the consumer during this period of apparent unrest.

Vix complacent

There may be two or three other indicators to watch. In the lead up to Thanksgiving equity market volatility as measured by the VIX index fell to its lows of the year this suggests a degree of complacency in markets as to the risks ahead. I would not be surprised to see the VIX spike higher in the early part of next week.

In addition if the mood in markets turns more cautious we may see a continuation of the rally in bond markets for much of this year. While inflation has been a concern bond prices have fallen and bond yields have pushed to new recent highs but bonds may rally because a weaker Chinese economy should lead to weaker global inflation and therefore create an interesting backdrop for bond prices and for yields to come down though this does not necessarily mean a supportive environment for equities because growth will be lower as well.

So as we go into next week the early things indicators to watch for are any weakness in the Chinese currency and local stock markets weakness in companies like Apple and also a spike higher in some of the American market volatility indicators