China Monitor: Staying Long With Inflation No Concern

Summary

• We examine policy, politics, and markets in this China Monitor.
• Inflation is not a concern this year in China, as the mainland’s reopening dynamics differ from the West’s experience.
• The economic data so far this year has supported the ‘Long China’ trade.
• Strategy:
  • We hold long A-shares (targeting SHCOMP of 3,500), having rotated out of long Hang Seng last month.
  • We hold long CNH, targeting 6.65: the renminbi has been well supported in the last two weeks despite USD strength.

China CPI Ticks Up, But Is No Concern

One of the common questions we have received is whether China’s reopening presents an inflation risk, for China itself and the world. Our answer is broadly ‘No’.

To see why, we examine China’ s CPI components:

• The CPI’s largest component is food (~20%), of which in turn the largest component is pork (>30%). Pork prices were rising last year during the Covid lockdowns. But this has now turned: pork prices are coming off as the production chain has normalized. For the whole CPI, the declining food component should have a significant stabilizing impact and offset other rising components (Chart 1).

• The non-food components of the CPI are more typical of the CPI that we see in other countries: transportation, education, health, rent, etc. These components should mostly rise this year as the economy reopens.
• Areas related to tourism (i.e., travel, dining out) and commodities (gradual recovery of the housing market + infra spending) will see bigger boosts.
• But there are significant caveats:
  • Supply chains that were broken last year have all been repaired. So, goods prices will not necessarily rise. China’s PPI is running at a negative -0.8% YoY.
  • Among commodities, oil prices are down YoY. This will keep transportation CPI in check.

I therefore think the benign expectations for China’s overall onshore inflation this year are correct. Negative factors broadly offset positive factors.  From the current 2.1% (headline YoY) and 1.0% (core YoY), consensus expects to end the year at around 3%. I.e., the uniqueness of the China reopening suggests a different CPI path than experienced by countries.

For inflation in the rest of the world, two transmission channels matter most: metals and outbound tourism. Metals are driven by a gradual pickup of property and infrastructure activity (China imports over 50% of all metals volumes globally). Outbound tourism, while starting slowly in January, will rise as airline connections towards and from China pick up in the months ahead. For the full year, China outbound tourism should reach 60-70% of pre-pandemic levels, with 2H on par with 2019.

CNY Yield Curve Shows Little Concern About Inflation

The shape of the Chinese yield curve suggests onshore investors are sanguine about inflation. A simple history of 1/5s in IRS (Chart 2) shows we now have the steepest curve since 2010 (i.e., 60bp). In other words, a steeper pickup in inflation and rates is priced in than anything in the last decade. But, importantly, the curve was still much steeper (around 150bp) during China’s mega-stimulus in 2010. Obviously, stimulus this year is strong, but it is nothing compared with then. It is fair therefore to expect PBOC to raise OMO and repo rates in 2H, but the magnitude will be small (50bp, maybe).

February Economic Data Still Supports the Long China Trade

The most recent China data was Friday evening’s loan data. There are two key points:

1. Aggregate financing was a very high CNY 5.4tn. January is always the strongest month for loan data. But this year saw a big push by the authorities to boost the reopening.
2. Corporate bond financing was on the lower side. But this should not be seen as a concern. A selloff in the corporate bond market during December/January has (temporarily) reduced buying appetite of new corporate issues.

More broadly, how has the relevant China data fared so far in February?

• All PMI’s bounced back above 50 (with one exception: the Caixin Manufacturing PMI).
• Mobility data for the Lunar New Year week was 90% of last year’s (train and metro data).
• Property sales data for the first five weeks of the year are flat YoY. This is a good result because there were no lockdowns last year during January and February.

The above data flow gives little to suggest we should take profit on the long China-themed trades, as the reopening appears to be going swiftly.

Our strategy remains:

• We hold long A-shares (targeting SHCOMP of 3,500), having rotated out of long Hang Seng last month.
• We hold long CNH, targeting 6.65: the renminbi has been well supported in the last two weeks despite USD strength.

Bert Gochet is a strategist at Macro Hive, specialising in Emerging Markets strategy. Between 2009 and 2017, he was co-head of global EM strategy with a focus on fixed income and currencies at JP Morgan.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)