By Geoffrey Smith
Investing.com -- After resisting it for over two years, the yuan has finally caught Covid.
China’s currency has weakened more quickly in the last week than at any time since 2015, losing nearly 3% against a dollar turbocharged by expectations of interest rate hikes from the Federal Reserve.
By 12 PM ET (1600 GMT) on Tuesday, the dollar was at 6.5893 against the offshore yuan, at what looks like the start of one of its periodic and abrupt revaluations. Previous similar episodes - in 2015, as the country flirted with producer price deflation, and in 2018, when Donald Trump declared a trade war on China – suggest the yuan could lose 10% or more against the dollar before bottoming out.
Like those two periods, the current attack of weakness reflects a very real risk to the country’s economic health. The coronavirus first identified in Wuhan has completed its round the world trip, returning in a form that is less lethal, but much more difficult to control. The authorities’ heavy-handed use of lockdowns to stamp out any trace of the disease may have worked against the initial Wuhan strain, but appear ill-suited to tackling the insidious Omicron strain and its subvariants.
The effect is two-fold: extreme lockdowns have crushed consumer demand in cities such as Shanghai and regions such as Jilin in the northeast of the country, and appear set to do the same in the capital Beijing, which imposed three rounds of mass testing on the city’s 21 million inhabitants this week. Shanghai has been under varying degrees of lockdown since March but is still no closer to eradicating the disease. Indeed, footage of steel fences being erected around houses and districts in the city at the weekend suggests the opposite.
The demand shock has made itself evident in a 3.5% year-on-year drop in retail sales in March while the Caixin Services Purchasing Managers Index plummeted to 40.2 in the same month, a level that would normally imply sharp contraction (as it did at the start of the pandemic, the last time it hit that level).
At the same time, the lockdowns are gumming up ever-larger swathes of China’s manufacturing sector, the workshop of the 21st century world. Caixin’s manufacturing PMI also fell below 50 in March, as manufacturers including Tesla (NASDAQ:TSLA) and Volkswagen (ETR:VOWG_p) were forced to suspend production for three weeks and more. Foxconn, the largest contract manufacturer of Apple’s iPhone, avoided a similar fate in Zhengzhou by forcing its staff to work in a bubble, but Pegatron, a smaller iPhone contractor, had to shut its plants in Shanghai and Kunshan.
Meanwhile, congestion at the port of Shanghai - arguably the world’s most important export facility - is threatening fresh supply chain disruptions to U.S. and European retailers and factories. According to the consultancy FourKites, volumes coming out of Shanghai have fallen by around 23% on average since the lockdowns started, while the ‘dwell time’ for ships arriving has more than doubled.
Shelley Simpson, chief commercial officer of logistics firm JB Hunt (NASDAQ:JBHT) JBHT, told analysts on a conference call last week that the situation is looking precarious and is likely to get “a lot worse in the summer months,” only a few weeks after it seemed that the world economy was starting to put pandemic-driven dislocations behind it.
“In this type of an environment just takes a little bit of disruption to really change the environment all over again,” Simpson said.
There appears little chance of a change of heart by the authorities in the near term. President Xi Jinping renewed his commitment to it in a closely-watched speech this week, despite having pledged to soften the approach to cushion its impact on the economy two months ago.
Which merely leaves others to pick up the pieces. The central bank on Tuesday stopped the yuan’s decline and the selling in local stock markets by promising further measures to support the economy, but a similar rally after the previous round of monetary and economic support measures quickly fizzled. China’s benchmark stock indices are trading at or close to two-year lows, down as much as 33% since the start of the year.
In recent years, any slowdown in China has typically meant trouble for the commodity exporters that feed its insatiable appetite for raw materials, food and energy. That may be more of a relief than a problem this time round, given the overheating of many commodity markets.
However, the importance of China to the world economy means that any failure by the authorities to engineer a soft landing will be felt far and wide. The world may be forgiven for thinking it’s done with Covid, but the reality is that – one way or another – Covid isn’t yet finished with the world.