China - A more cautious approach to policy normalization amidst continuation of the recovery

-->China - A more cautious approach to policy normalization amidst continuation of the recovery                    

• CNY: Tighter domestic liquidity conditions but a weaker CNH - USDCNH breaks above 6.50 yesterday (if only briefly) as USDCNY daily fixing hits 6.4845, +212 pips from the last fixing and +93 pips from the last closing at 6.4752. And late last week, PBoC catches markets by surprise with a smaller than expected MLF operation of RMB500bn, somewhat disappointing given the recent spate of liquidity withdrawals and expiries and with Lunar New Year holidays round the corner. Policy exit towards normalization but with caution: takeaways from PBoC Yi’s interview - PBoC Governor Yi G in an interview to the Chinese press on January 8, sheds light on China’s monetary policy outlook for 2021 and RMB exchange rate policy. Key takeaways – (1) stresses importance of monetary policy stability and continuity and reiterates the need to create room to normalize policy for sustainability – says the PBoC will ensure M2 and TSF growth is kept at a pace roughly consistent with nominal GDP; (2) Market-oriented reform for deposit rates to be pushed forward this year. Also looks to stabilize banks’ funding costs and enhance central bank’s policy rate transmission and benchmark money market rates; (3) Pledge to enhance flexibility of RMB exchange rate and better manage expectations on RMB – RMB internationalization will be pushed forward, and the formation of RMB exchange rate mechanism to be enhanced further. Since mid-December, PBoC has unveiled a set of measures to encourage capital outflows to encourage more 2-way flows.       

  CNY: Chinese activity momentum continues but follows a narrower path - Real GDP growth picks up from 4.9%YoY in Q3 to 6.5%YoY in Q4 (Citi/Mkt: 5.9%/6.2%YoY), leaving full-year growth at 2.3%YoY for 2020. But apart from industrial production, other components are weaker or below consensus. Headline FAI growth marches up from 2.6%YoY Ytd in November to 2.9%YoY Ytd in December, but below consensus (Citi/Mkt: 3.2%YoY Ytd). Retail sales weaken from 5.0%YoY in November to 4.6%YoY, below market consensus (Citi/Mkt: 6.1%/5.5%YoY). But industrial production accelerates further from 7.0%YoY in November to 7.3%YoY, higher than expected (Citi/Mkt: 7.0%/6.9%YoY) though could be weather related. What next? – Citi analysts expect a near term Covid-related slowdown is unlikely to derail China’s overall growth outlook for 2021. PBoC is expected to continue its exit from the pandemic-era monetary policy, but taking a more cautious approach with no MLF rate hikes seen in 2021 but little chance of RRR cuts either. The team expects PBoC to become more proactive in conducting its open market operations to keep liquidity ample enough to sustain the recovery (read - slowly tightening financial conditions as recovery continues) and the team maintains its forecast of 6.3 on USDCNY by mid-year (a small 20 pip gain from current spot over the next 6 months compared to the 70 pip gain over the 6 months prior - June to Dec 2020).     

   

China’s bond markets receive record high annual inflow in 2020    

• CNY: China’s fixed income markets inflows in 2020 more than double from US$66bn in 2019 to US$155bn in 2020, largely from long-term institutional investors. Supported by persistent RMB strength (or the other way round with bond inflows strengthening RMB) and larger yield spreads with developed markets, foreign inflows into China’s bond market accelerate after a small outflow in March, 2020. As per Citi analysts estimate, inclusion into Bloomberg Barclays Global Aggregate & JPM GBI-EM contributes a total of US$103bn inflow in 2020, or ~66% of the total annual inflows. Meanwhile, IMF COFER data shows global central banks having increased CNY asset holding by US$30bn.     

Week Ahead   

• EUR: ECB Monetary Policy meeting – Refi Rate Forecast: 0.00% Prior: 0.00%; Deposit Facility Forecast: -0.50% Prior: -0.50%; Marginal Lending Facility Forecast: 0.25% Prior: 0.25% - Citi analysts do not expect any changes on policy or communication but it is of interest to see what message President Lagarde sends with respect to the near-term outlook and risks surrounding the baseline and current strength in EUR and impact on euro area’s longer term inflation outlook.  

• JPY: BoJ board meeting - Will the BoJ broaden its YCC range? - Media reports over the weekend suggest the BoJ may broaden the range for its YCC (yield curve control) at this week’s board meeting. BoJ currently sets the 10yr JGB yield target at 0%, while setting the policy rate at -0.1% and the JGB yields range at ±0.2%. Citi analysts however think it unlikely that the BoJ further widens the trading band of its 10Yr JGB yield at this week’s meeting.

• EUR: Euro area Manufacturing PMI, January Flash Forecast: 57.0 Prior: 55.2; Services PMI, January Flash Forecast: 43.0 Prior: 46.4;  Composite PMI, January Flash Forecast: 47.5 Prior: 49.1 – Citi analysts estimate the flash composite PMI will fall in January, by around 1.5, signaling economic activity is contracting due to lockdowns but the impact is smaller than in November, let alone spring.      

• EUR: German ZEW Expectations, January Forecast: 60 Prior: 55.0; ZEW Current Assessment, January Forecast: -70 Prior: -66.5 - Vaccine roll-out, more US fiscal stimulus and central bank support, have helped equity markets in Germany to surge, which will likely be reflected in investor expectations. 

• GBP: Manufacturing PMI, January Flash Forecast: 52.5 Prior (Nov Final): 57.5 – Citi analysts expect the UK headline manufacturing PMI to fall back sharply this month as recent data has been flattered by both Brexit stockpiling effects and growing pressure on supply chains. 

• GBP: Services PMI, January Flash Forecast: 40.3 Prior (Nov Final): 49.4 – Citi analysts expect UK services sector to be hit hard by the move on 4 January back into a national lockdown.  

• CAD: Bank of Canada Rate Decision – Citi: 0.25%, median: 0.25%, prior: 0.25% - Citi analysts are most curious to hear about any possible guidance around upcoming changes to monetary policy. Citi’s base case continues to be that the next adjustment to monetary policy will be to allow for a slower pace of weekly bond purchases later this year (possibly the April BoC meeting).  

This is an extract from the Daily Currency Update, dated January 18, 2021. Please approach a Citigold Relationship Manager if you would like more information.