Huge Economic Contraction in China Underway
In the first quarter of 2020, the Chinese economy contracted at a rate of 9.8% Q/Q, and was 6.8% smaller than in Q1 2019.
The last time we saw such a big contraction in the Chinese economy was back in 1967, when China experienced growth of -5.8% during the Cultural Revolution (which was characterised by widespread famine and destitution).
The data highlights the impact of near-total national lockdowns implemented towards the back end of January to curb the spread of Covid-19. According to official data, by mid-February, the rate at which the virus was spreading in China had come down significantly and lower risk regions were gradually allowed back to work.
This “return to work” can be seen in a decent improvement in Industrial production data for March when compared to February; Industrial Production in March shrunk at a rate of just 1.1% Y/Y, much higher than expectations for a 7.3% decline.
But this gradual return in production was clearly not enough to offset the decline in service activity or fall in consumer spending.
Retail sales shrunk at a rate of 15.8% Y/Y in March, much worse than the 10% Y/Y expected decline.
Unfortunately for China, their outlook for a swift recovery is poor. The rest of the world, on whom China is heavily reliant for trade, went into lockdown in March and faces a similar hit to GDP as does China. China’s economic recovery, therefore, is much more likely to look “U” shaped rather than “V” shaped.
How did the market react?
Markets largely shrugged off the Chinese data, despite it being broadly worse than expected (markets were looking for a rate of contraction of 6% Y/Y, not 6.8%).
Focus instead was on reports that a Gilead’s Remdesivir antiviral drug was showing promise in clinical trials as a means of treating patients who are severely ill with Covid-19. Moreover, US President Trump unveiled guidelines for a phased return back to normality for the US economy.
Overnight, global equity markets rallied hard on the double dose of bullish catalysts. However, since the US cash equity open, much of these gains have been given back. After all, the results of the Remdesivir study are still far from conclusive and Trump’s guidelines leave the bulk of decision making responsibility up to the individual State Governors.
Nonetheless, it seems these two events were the perfect distraction at the time from more hard evidence of the economic destruction being caused by the virus. As more evidence of this comes, in the form of more and more up to date data in the coming weeks, the economic reality will become harder to ignore.
More broadly, stock markets have priced in the sharp coming recession. But they also seem to be pricing a rapid recovery. If these reports about Remdesivir turn out correct and it is some kind of wonder drug, we could be in for that “V” shaped recovery that is being so hoped for.
Otherwise, prolonged economic pain is likely as countries ease lockdowns little by little, only allowing partial economic recovery.
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