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Don’t count China out just yet

Don’t count China out just yet

(Peter Rosenstreich, head of market strategy)

Quietly, China economic conditions are showing signs of further recovery. While financial markets have been focused on China's rapidly declining reserves and speculation for additional RMB devaluation, economic stabilization is now firming. The PBoC reported that total November FX reserves stood at $3.052trn, versus $3.121trn ($69bln decline). China’s CPI inflation continued to trend higher in November climbing up 2.3% y/y from 2.1% in October. PPI inflation jumped to 3.3% in the same time period indicating the quickest pace increase since January 2010. Consumer non-food inflation was heavily influenced by housing prices which rose 2.0% nearly a three year high. Producer price surges were due to a rally in commodity prices and strong domestic demand. China November commodity imports surged across the board (crude oil, copper & iron ore and coal recorded big increases) indicating economic strength in the industrial sectors. Combining today’s inflation read with improving trade data and better PMI (including export order components) reads there are clear signs of stabilizing growth and potential for GDP to surprise to the upside. In USD terms, exports increased 0.1% y/y, from a dismal -7.3% in October, reversing more than a year of contraction. Interestingly, China’s trade with US, Japan and Europe all improved significantly. Current expectations point to Q4 GDP 6.4-5% which seems low considering the improvement.

In regards to monetary policy, the depreciation in the RMB and upward trend inflation suggest a mild tightening stance. Given our single 25bp hike for the Fed in 2017, it is unlikely that the PBoC will adjust the benchmark interest rates. However, should the Fed normalization path steepen or “Trumponomics” trigger further unstable capital outflows from China we could anticipate a rate hike. The PBoC will stay focused on managing pressure on RMB through direct FX intervention and pushing up borrowing costs among other micro-tuning methods. As for the RMB, we are less negative on the currency than the street due to under appreciation of the current economic recovery and the importance of currency “optics” to China. Heading toward a clear showdown with US President Trump, China is likely to control further depreciation in order to look less culpable. In the mid-term we would be seller of USDCNH, content to pick up the yield differential.

First the ECB…

(Arnaud Masset, market analyst)

The US dollar was the big winner yesterday amid the ECB's decision to extend its quantitative easing programme as it surged on a broad basis with the dollar index gaining 1.40% up to 101.20, while the single currency dropped. The European central bank announced an extension of its QE by nine months until December 2017 but trimmed the monthly purchase target to €60bn per month from €80bn. In addition, Mario Draghi eased the buying rules, allowing the purchase of bonds yielding below -0.4% - the current ECB’s deposit rate - and extending the maturity range for eligible securities. The combination of these measures could signal the beginning of tapering; however we believe the ECB is more concerned about potential liquidity issues, which would explain the lowering of the size of the QE. But to mitigate the negative impact this QE reduction would have had on the market, he announced the two latter measures, preventing a sharp EUR appreciation, and argued that it was mostly due to the fact that deflationary risk had largely disappeared. EUR/USD fell 2% to 1.0610 after the announcement and has been trading trendless around that level since then.

… Then the Fed

The December meeting of the Federal Reserve has been long awaited as it was seen as the only opportunity for an interest rate hike. The Fed has therefore done the job of preparing the market for this move. We believe that the upcoming tightening move is fully priced in, meaning that the Fed could only disappoint should Janet Yellen send some dovish signals at the press conference that follows the rate decision. The “Trump effect” is also slowly fading as market participants realised it will take months, if not years, for the incoming US president to give life to his campaign promise. All in all we believe that the dollar rally is coming to an end as downside correction is becoming more and more likely. Be ready for dollar weakness as we start 2017.

Friday, 09 Dec, 2016 / 10:33

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