Treasury Reaction To China Outbreak Has Little Staying Power

By Ven Ram, Bloomberg markets live commentator and reporter

When the Chinese economy is in distress, it’s never local. So the global reaction to the recent slump in Shanghai stocks and the yuan shouldn’t have come as much of a surprise.

Traders swiftly turned long duration — and short optimism. Except that the reaction may not have much by way of endurance. For, once the immediate gloom lifts, long-dated Treasury yields may bounce back harder and with greater vigor — as they seem to suggest this morning.

When lockdowns and Covid Zero crimp output from Beijing to Shanghai, China — being the factory to the world — imports weakness in its economy and starts to export inflation to the global markets. Already, anecdotal reports of how supplies due from the mainland to far-flung destinations have been stalled without any firm arrival date abound, and the latest scare will only make those bottlenecks worse.

Producer prices everywhere are soaring like eagles across the sky, and what will the latest turn of events in China portend for the sticker price of goods made elsewhere in the world but reliant on those already-elusive manufacturing inputs from Shanghai? Well, suffice to say that the denouement perhaps spells “Not great”. In other words, this doesn’t smell anything like the inflation that will be back on its haunches as soon as the second half as some policy makers believe will happen.

In all this, there is a small chance that Monday’s market reaction resumes. And that’s a scenario predicated on the outbreak in Beijing spilling over into other cities and the pandemic taking on proportions a la what we saw in early 2020. Remote as that possibility now seems, who out there knows the vector of transmission so well as to completely rule out such a narrative? Any such eventuality will hurt global growth big time and entrench Monday’s tone in the markets.

Save that scenario, it is safe to say that the latest episode makes central banks’ challenging agenda on quelling inflation even more daunting. Clearly, what happens in China doesn’t just stay there.