China Monitor: More Lockdowns, Policy Vacuum Hint at Further Downside

Summary

• We examine policy, politics, and markets in this bi-weekly China Monitor.
• Lockdowns are increasing as local governments must show loyalty to the zero-Covid policy ahead of the Party Congress.
• Recent policies to boost the ailing property market are unlikely to revive the sector, even if property bonds saw a small price bounce.
• The government’s focus until November will not be on economics but politics.
• With 3Q looking like another ‘lost quarter’ for the economy, GDP growth forecasts for 2022 are drifting towards a 2% handle.
• We now think CNY can break 7.0 anytime. A PBOC press conference this week suggested the big figure is not a red line.

Lockdowns Increasing…Again

As we head towards the Party Congress, local governments face pressure to adhere fully to the zero-Covid policy and lock down their cities at the merest sign of Covid infections. By one metric, 35% of Chinese cities are now in some form of lockdown. That is more than in April and at any time since the early months of the pandemic in 2020.

The increase in lockdowns is understandable. For those local leaders wishing to benefit from the Party Congress, a last-minute Covid flareup in their region will almost certainly hamper their prospects for a promotion. In effect, the zero-Covid policy is a loyalty requirement for all local cadres, and they will eagerly implement it for the next couple of months.

Property Policies Are Too Little Too Late

After a weak August, the Chinese economy enters September on the same weak path, not only due to the zero-Covid lockdown strategy but also the frozen property sector. The last few weeks saw several measures to support property, but their size and potential is too small to do more than backfill some currently stalled projects.

China assets did not benefit from these property policies (Table 1). Equity markets are trading at their lowest in three months. Admittedly, the USD Asia ex-Japan High Yield Bond Index saw a small 5% uptick in the past few weeks. But that is because developer bonds comprise an outsized share of the index, and bonds are already trading in highly distressed territory (5-30 cents on the dollar; Chart 1). China has arrived in a policy vacuum that will last until at least the Party Congress.

Monetary Policy Remains Constrained

Meanwhile, PBOC interest rate policy remains constrained. The 5-year LPR, the benchmark for mortgages, was cut by 15bp (to 4.30%), but markets shrugged. More generally, official policy rates, such as MLF, are stuck at the lows (2.75%), with little scope to cut further. Inflation, now at 2.7%, is rising, and the August reading will sit above the PBOC’s 3% target. More broadly, the central bank knows liquidity is already too plentiful and that rate cuts will not increase loan demand. CGB yields are stuck at the lows. Besides China, there is only one outlier in the global race to raise rates: Japan (Chart 2).

Metal Prices Test the Downside of the Range

A Chinese policy vacuum opens further downside for commodity prices. During August, oil, iron ore and copper prices seemed like they were forming a base (Chart 3). But, with the Caixin Manufacturing PMI coming in under 50 last week, sentiment for metals soured again. Later this week, we will get a breakdown of China’s imports for August. If the trend of the last few months is indicative, import volumes will again have decreased (Chart 4). For iron ore and copper, the risk is for prices to break out of the recent range on the downside, despite low inventories.

CNH: We Now Think 7.0 Will Break

Just this week, China cut its FX Reserve Ratio (FXRR) from 8% to 6% to try to stem FX depreciation. CNH shrugged off the decision at the time, with spot dropping 100 pips (from 6.95 to 6.94) before recovering the next day. As recently as April, a similar FXRR cut resulted in a 600-pip move, when USD/CNH fell from 6.60 to 6.54. But China’s current problems are just too manifold for piecemeal policies, such as fiddling with the FXRR, to impact markets.

We now think CNY will break 7.0. In a press conference this week, PBOC called the currency market ‘stable’, and suggested RMB is ‘still expensive’. USD/CNH has drifted up to 6.97 as of the time of writing, and there were few signs of official USD selling in recent days that makes us think PBOC really wants to defend the 7 big figure.

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.)