China unrest : Uncertainty vs Pragmatism

The reported unrest in China is the key theme of the weekend headlines. The extent to which markets are impacted should be viewed through the lens of reopening prospects.

Risk sentiment opens with a case of China derisking jitters amid untypical and growing unrest as citizens take to the streets to protest Covid zero.

Any hopes that a slight relaxation of Covid measures would act as a market and civil unrest circuit breaker of sorts have given way to fears that China policymakers might have another Tiananmen square uprising on their hands.

And it certainly doesn’t help when many are confined to their apartments watching the World Cup, saw thousands of mask-less fans in Qatar enjoying life that has long been lost in COVID zero haze.

Social discontent could increase in China over the coming months testing policymakers’ resolve to stick to the COVID zero mandates. And since China’s economy is currently in a tug-of-war between weakening macroeconomic fundamentals and increasing reopening hopes. Mass protests would deeply tilt the scales in favour of an even weaker economy and likely be accompanied by a massive surge in Covid cases, leaving policymakers with a considerable dilemma.

For China’s official institutions, there are no easy paths. Accelerating reopening plans when new covid cases are rising is unlikely, given the low vaccination coverage of the elderly.

For investors, when it comes to China, trying to predict with any degree the reopening certainty that has no certainty, basis, or track record to go by is looking like a dangerous game in the context of the disquietening protests and the colossal challenge China’s leaders now have on their hands.

The currency market is the simplest barometer to gauge what onshore and offshore markets think. With USDCNH flashing outflow red driven by protests and domestic Covid cases trending higher, it suggests that investors are running ice cold on China. And typically, this type of hostile Monday morning currency reception will have magnetism over the lengthy list of local currency betas that export into China.

In the near term, China equities and CNH volatility gauges will likely price in more significant uncertainty around the reaction function to protests and the potential that zero tolerance in this part of public policy will drive tighter Covid restrictions. However, the more pragmatic and likely outcome is a quicker loosening of restrictions once the current wave subsides. That implies selling rallies in USDCNH and all other associated betas getting battered this morning.