At the beginning of 2023, if we have certainty about anything, it’s how uncertain the path is for the global economy.
Perhaps most underappreciated are the two-sided risks from China’s chaotic reopening. Views appear to have converged around how it will play out: near-term disruption followed by a potent post-Covid mini-boom in the second quarter of the year.
However, much remains unclear about China’s Covid situation, let alone what will happen as normal economic life resumes. Neither economists nor epidemiologists have had a particularly impressive forecasting record over the past two years.
There is lots of emphasis on reopening, probably not enough on chaos.
Chaos
For most of the past three years, China’s goods economy has been shielded from Covid by continued lockdowns and restrictions. But in the coming weeks, lots of people won’t make their factory shifts. Soaring demand for labour-intensive consumer services must contend with a Covid-disrupted workforce. China’s reopening will fan the inflationary flames, just as we saw in the West.
Optimists might argue that, after a short period of manageable chaos, China will enjoy an unexpectedly powerful rebound. The three bears disappear off into the woods and Goldilocks returns: US disinflation, peak Federal Reserve (Fed) hawkishness and a China-led growth acceleration.
Homegrown inflation in China, higher commodity prices and relief from a strong dollar might trigger a risk-on environment. However, that would be unlikely to last long, given the inevitable hawkish response from twitchy central banks. Until inflation pressures subside dramatically, good news on the economy will probably be bad news for risk assets.
Perhaps it is much simpler than everyone thinks. Collateral damage from China’s reopening merely accelerates a global earnings slump. An unexpectedly strong rebound, especially if accompanied by a resurgent property market, will force the Fed to hit the brakes even harder.
If Fed chair Jerome Powell is serious about emulating Paul Volcker’s feat of truly taming inflation, financial conditions may need to tighten significantly further in 2023.
Ajay Johal is an investment manager at Ruffer
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