Chinese Markets Tank as Investors Worry About Covid-19 Lockdowns

Chinese stocks suffered their worst selloff in more than two years and the yuan hit its lowest level since late 2020, as investors worried that strict policies to combat Covid-19 would add to the pressures weighing on China’s economic growth and corporate profits.

The battle with the Omicron variant of Covid-19 is adding to a series of challenges for China’s economy and markets, on top of domestic regulatory crackdowns, the war in Ukraine, and a shift toward tighter monetary policy by many central banks to tackle galloping inflation .

Residents in China’s capital, Beijing, were stocking up on essentials Monday in anticipation of a possible lockdown, as a severe lockdown in Shanghai entered its fifth week. Beijing officials began mass Covid-19 tests of people living or working in the city’s Chaoyang district.

Economists have slashed their forecasts for Chinese expansion, with the International Monetary Fund last week cutting its 2022 growth forecast for the country to 4.4% and banks downgrading their predictions. Foreign investors have pulled billions of dollars from Chinese stock and bond markets.

On Monday, the Shanghai Composite and CSI 300 indexes fell 5.1% and 4.9% respectively. Those were the largest single-day percentage declines for both benchmarks since February 2020, when anxiety over the fast-spreading coronavirus in the early days of the pandemic led to sharp falls in Chinese markets after the Lunar New Year holiday.

The offshore yuan fell steeply, weakening past 6.60 against the dollar, according to FactSet. The decline built on a selloff last week that ended months of relative stability. Shortly after the currency crossed 6.60 per dollar, China’s central bank said it would tweak its foreign-exchange policy, helping the yuan pare some of its earlier losses.

The market is recognizing “economic recovery will be delayed and the situation in China could be more uncertain, especially in the near term, because of the Omicron situation,” said Jason Liu, the Asia head of the chief investment office at Deutsche Bank’s international private bank.

“The market is starting to realize that the overall stimulus measures from China could be smaller than expectations or quite delayed, especially on the monetary side,” Mr. Liu said.

In US trading, stocks finished Monday higher after a volatile session. The S&P 500 closed 0.6% higher after earlier falling nearly 1.7%. The 10-year Treasury yield fell to 2.825% from 2.905% Friday, its largest one-day yield decline since March 4.

Monday’s rout in the CSI 300 took the year-to-date decline in the blue-chip index, which includes the biggest stocks listed in either Shanghai or Shenzhen, to nearly 23%. The broad Shanghai Composite has lost nearly 20% over the same period.

Raw-materials companies were among the biggest decliners Monday, with Tianqi Lithium dropping 9.9% and rival Ganfeng Lithium dropping 9.1%.

The pullback was echoed in offshore stocks in Hong Kong, where the city’s flagship Hang Seng Index retreated 3.7%. Haidilao, which operates a chain of hot-pot restaurants in China, led major decliners, losing 16%.

Covid-19 restrictions have emerged as the largest threat to China’s growth, analysts at several onshore securities firms said in notes to clients. These curbs may hurt more in the second quarter than the first, said Xuan Wei, chief strategist of Beijing-based China Asset Management.

As Shanghai remains locked down amid China’s biggest Covid-19 outbreak, residents are taking to social media to vent about a shortage of food or they’re bartering with neighbors. Anxiety and hunger are prompting many to question Beijing’s pandemic strategy. Photo: Chinatopix Via AP

China was already confronting weak consumer demand, and the lockdowns have exacerbated that weakness, helping explain the stock selloff, said Patrick Ru, a portfolio manager on Neuberger Berman’s global equity team.

Part of the stress on Chinese markets comes from foreigners scaling back their positions. Last month, international investors cut their holdings of Chinese bonds by a record $ 15 billion, and sold a net total of about $ 7.1 billion of Chinese stocks through a trading link with Hong Kong known as Stock Connect.

As Treasury yields have surged, the extra yield offered by China’s government bonds over their US equivalents has shrunk, reducing the relative appeal of Chinese debt.

The shrinking of that gap, plus rising risks to Chinese growth, prompted speculative investors to liquidate their yuan holdings, and led to a buildup of tactical bets against the currency, said Lemon Zhang, a foreign-exchange and emerging-markets macro strategist at Barclays .

A Covid testing site in Beijing’s Chaoyang district.


Photo:

Ju Huanzong / Zuma Press

Still, she said the People’s Bank of China probably wouldn’t allow a large near-term depreciation of the currency, pointing to its recent record of setting a midpoint for onshore yuan trading that was stronger than implied by market prices.

Late Monday Beijing time, the PBOC said it would require financial firms to hold smaller amounts of foreign currency in reserve. The offshore yuan regained some ground to trade at about 6,586 per dollar, a level that still put it on course for its weakest settle since November 2020.

The central bank said it would cut the foreign-exchange reserve requirement ratio next month by 1 percentage point to 8%, to improve liquidity in that market. It lifted this ratio twice last year, to 9% from 5%, in moves that analysts said were meant to ease appreciation pressures on a then-strong currency.

Data for cross-border bond investment in April is not available yet. In equities, foreigners dumped the equivalent of $ 676 million of Chinese shares Monday through Stock Connect, Wind data showed. After modest inflows earlier in April, month-to-date outflows total $ 494 million.

Monday’s declines mean Chinese domestic stocks have now erased all of their gains they made since recovering from a trough in mid-March. That rebound was fueled by Vice Premier Liu He, who stepped in to stop a slide in share prices by pledging a series of market-friendly measures.

Officials have since made fresh efforts to reassure investors. Last week Fang Xinghai, vice chairman of the China Securities Regulatory Commission, said he believed that any foreign pullback from Chinese assets would only be a short-term move, while the commission told onshore institutions to act as long-term investors and “overcome short -term market fluctuations. ”

A spokeswoman for the State Administration of Foreign Exchange, the foreign-exchange regulator, also last week assured investors that the Chinese economy is resilient and yuan-denominated assets had long-term investment value.

Write to Rebecca Feng at rebecca.feng@wsj.com and Dave Sebastian at dave.sebastian@wsj.com

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