In brief

• China’s policy stance towards COVID-zero is unwavering, creating further downward pressure on the economic outlook and negative market sentiment.
• The impact on supply chains has been modest so far, but data may be lagging and a return to more normal levels of supply chain logistics may be some time away.
• A policy setting that shifts towards balances pandemic control and economic growth, as well as further fiscal and monetary policy support may improve market sentiment. 

The onset of the COVID-19 pandemic has stressed global supply chains, creating inflationary pressures and weighing on the economic outlook. There had been tentative improvements in supply chains as supplier delivery times improved and more normal activities resumed. However, the spread of the Omicron variant in China, and subsequent restrictions, is again squeezing supply chains.

The current COVID-19 wave spreading across China is larger than that experienced in 2020. The initial indicators suggested the impact on supply chains was less severe this time around. However, the continued stringent policy controls being implemented by China’s central government means that pressures are unlikely to ease in the near term. Only the adoption of policies that balance controlling the spread of the virus and the broader resumption in economic activity are likely to reverse the current trend.

After improving in the first two months of the year, supply chain indicators deteriorated in March in line with the restrictions imposed across Chinese cities. The sharp decline in the April Purchasing Managers’ Indices to contraction territory, and rise in delivery times, reflected the mounting pressure on the Chinese economy.

Meanwhile, a survey conducted by the American Chamber of Commerce in China in April reported that 86% of manufacturing faced disruptions to trucking and shipping networks that impacted their supply chains. Full truck load freight fell by 46% year-over-year from the peak on March 11 and trough on April 7 for China, when local governments adopted stringent pandemic control measures on highways. Some local governments have taken steps to ease transport and logistic logjams, such as Jiangsu, Zhejiang and Guangdong, by reopening closed road toll stations. Exhibit 1 from the Guide to China illustrates the difference in truck freight in Shanghai compared to the rest of the country.

The impact on shipping freight is mixed given reports of longer clearing times at Chinese ports and a backlog of ships outside of Shanghai’s port. However, container throughput—the total value of cargo discharged and loaded at a port—has been steady through March and April. This may be down to the use of “closed loop” systems to keep ports open and freight management from road to waterways to offset trucking induced delays.

Exhibit 1: Supply chain stress has increased in China since mid-March
Left: Truck freight index (2019 average = 100), right: daily new COVID-19 cases*

Source: G7 Internet of Things Platform, J.P. Morgan Asset Management.
*COVID-19 cases incorporate both confirmed and asymptomatic cases.
Guide to China. Data are as of April 28, 2022.

While the greatest disruptions have been felt in Shanghai and the Yangtze River Delta region, outbreaks across the country mean that supply chains for various sectors will experience a rolling impact. For example, many automobile chip and electronics producers are centralized in Shanghai, which led to sustained disruption risks to auto supply chains. The potential to for Beijing to adopt ‘Shanghai-style’ lockdowns could further disrupt the auto industry, but also electrical component manufacturing. Meanwhile, wider restrictions in the Hebei province would further impact steel production. 

The recent reiteration of the official hardline policy response of COVID-zero points towards heavy restrictions being in place for longer. However, there is recognition of the economic harm being done by the severity of the restrictions and the need to shift towards a policy setting that balances pandemic control and economic growth. The pace at which these policies are rolled out will greatly influence the inflationary impact of supply chain stress in other parts of the world.

The Politiburo meeting at the end of April called for the smooth flow of transport and logistics, and the normal operations of key supply chains and infrastructure. But it is still unclear how quickly supply chains and logistics could return to normal or how this may impact future order or potentially accelerate shifts in supply chains. If disruptions persist for an elongated period, then those reliant on Chinese manufacturing may be more motivated to relocate production.

The level of demand is also a key consideration as the spending habits of consumers in large export markets, such as the U.S., change. With greater freedoms, spending habits are shifting from consumables and physical goods to services, tourism and leisure. Chinese export data for April captured not only the Omicron-related supply disruption but also a decline in exports to the U.S. and Europe.

Investment implications

The situation in China is adding to both global inflation and growth concerns. While the Chinese economy will remain weak in the near term, we expect further stimulus to stabilize the outlook and ease some of the growth worries extending into the broader region.

Chinese supply chains present an upside risk to inflation across a range of outcomes. Further fiscal stimulus to kick-start domestic demand or infrastructure activity creates inflationary pressures and additional commodity demand. Meanwhile, continued lockdowns that squeeze supply chains also have inflationary implications.

The growth and inflation risks that investors face suggest a balanced approach to portfolio allocation in the near term. Upward pressure on core government bond yield keeps us cautious of advocating a larger weight towards duration. However, we see a longer-run opportunity in Chinese markets given the supportive policy stance and undemanding equity valuations.  

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