- China’s reopening from lockdowns is proving bumpy. Authorities imposed mass testing and limited activities to combat fresh outbreaks in Beijing and Shanghai.
- Government stimulus is helping the economy recover from Covid. But progress will be patchy, and China weakness is here to stay.
- Policy divergence between the PBOC and Fed and the prospect of continued capital outflows leave a negative outlook for the yuan.
- We are bearish CNH.
- We like to express this view via short CNH vs long SGD (We initiated this recommendation previously in our SGX Asia Currencies report).
China Is Still Struggling With Covid-19
China’s re-opening is proving bumpy. The beginning of June saw hopes that Shanghai and Beijing would finally lift their two-month-long lockdowns to stem the spread of Covid. But within days, there were fresh Covid outbreaks in both cities: 45 infections in Beijing, 37 in Shanghai.
While extraordinarily modest compared with most other countries, China authorities reiterated their zero tolerance for Covid. They imposed mass testing and limited activities like dining out. The pace of reopening and resuming more normal economic activity remains highly uncertain.
Stimulus Is Underway
China recently announced stimulus plans to help its economy recover from the Covid lockdowns and hopefully achieve its 5.5% GDP growth target for 2022. Among other things, these include:
- Easing limits on automobile ownership.
- Encouraging people to buy home appliances.
- Allowing REITs to raise money to invest in housing-related infrastructure.
- Creating special bond programs for local governments to finance infrastructure projects.
- Cutting some VAT taxes.
Bloomberg estimates China has announced plans to spend about USD 5tn on stimulus so far in 2022.
The Worst Is Over, But China Weakness Is Here to Stay
Recent activity data confirm the worst is now past for China. May real economy data all came in better than expected, reflecting the partial reopening from the tight restrictions through April.
However, retail sales came in at -6.7% YoY (and -1.5% YoY YTD). This reflects very weak domestic demand, with mobility remaining limited. Meanwhile, fixed asset investment and property investment are at 6.2% YoY and -4.4% YoY. These figures highlight the deep skew in the economy between policy-induced property market weakness and government efforts to stimulate infrastructure investment.
With China’s zero-Covid policy now focussed primarily on testing, growth momentum should continue to improve from the lows. But weak activity is here to stay. The renewed restrictions and delays in planned reopenings in Beijing and Shanghai suggest the recovery will remain incomplete for some time.
Accordingly, discussion over a possible contraction in Q2 GDP is heating up. And we retain our view that the theme of China weakness is here to stay.
The Fed’s Hikes Are Pressuring the Yuan
Heightened risk aversion ahead of the Fed hike on 15 June impacted China’s yuan less than other emerging-market currencies. Indeed, USD/CNH has traded in a 6.66-6.76 range over recent weeks. But pressure is mounting.
Earlier this week, some economists had expected a cut in China’s main interest rate (the 1-year MLF). After all, the PBOC cut mortgage rates in May. But with the Fed’s 75bp hike fully priced ahead of the PBOC meeting, the MLF rate was left firmly on hold. And frontloaded Fed hikes remove the possibility of further modest rate cuts from the PBOC.
Despite the PBOC rate staying put, the latest spike in US rates has pushed the China-US yield differential deeper into negative territory. China government bond yields are now around 60 basis points below the US, pointing to further pressure on the yuan.
And capital outflows are set to continue. China’s equity markets have seen inflows return ($7.2bn MTD). But further inflows are unlikely to offset considerable ongoing bond outflows: May saw $2.1bn from government bonds and an unprecedented $11bn from policy bank bonds.
Together, the policy divergence between the PBOC and Fed and the prospect of continued capital outflows leave a negative outlook for the yuan.
How to Trade This View
We are bearish CNH, and we like to express this view via short CNH vs long SGD. We choose the Singapore dollar because we see currency strength ahead from additional monetary policy tightening. (We initiated this recommendation previously in our SGX Asia Currencies report.)