Macro Monday:Property and commodities outperform stocks and bonds

China stocks fell on liquidity concerns: Last week H-shares dipped 1%while A-shares slumped 4%, as investors were absorbing bad news from thebond market. China’s onshore bond market had a bull run over the past twoyears but recently it’s under pressure due to tighter liquidity and risingdefaults. Bond yields increased and credit spread widened (Fig 40and 41).Sentiment is completely different in the commodities market; trading in steeland iron ore futures was so hot that the Commodities Exchanges are raisingtransaction fees to cool down the market.

Stocks: better sentiment in H than A: Last week we visited clients in China.For A-share investors, their risk appetite seems still low, although better thanthree months ago. Many see the recent recovery as driven by stimulus whichruns against the long-term reform goals. By contrast, overseas investors aremore positive on China stocks as they focus more on China’s growth from aglobal point of view. After all, China’s short-term macro outlook is improvingwhile for most countries it’s deteriorating. In its latest update, the IMF revisedup China’s 2016GDP forecast from 6.3% to 6.5%, while it revised down itsglobal forecast from 3.4% to 3.2%. EM have also outperformed DM lately.

Property and commodities driven by liquidity and sentiment: To be sure,no matter from headline numbers or from grass-root checks, the currentrecovery is real. The improved fundamentals successfully triggered a rally incommodities futures. However, it’s now clearly more driven by liquidity andsentiment than fundamentals. As risk-free rates such as wealth managementproducts have continued to fall over the past two years (Fig 39), hot money inChina is flowing across various markets to hunt for returns, such as A-sharesin 1H15and credit bonds in 2H15. These days, abundant liquidity has turnedthe property and commodities markets into swamps. It’s worrisome as a hotproperty market could worsen housing oversupply by encouraging new starts,while rising commodities prices could slow the pace of cutting overcapacity.

Policy turning more neutral: In March, 70-city home prices jumped 11%mom (annualized) (Feb: 5%), while 62out of the 70cities saw home pricesincrease (Fig 31and 32). GFA property sales went up 33% yoy in 1Q15andlower-tier cities also recovered. Entering April, home sales moderated butwere still strong (Fig 35). Facing the hot property and commodities futuresmarkets, the PBoC is turning more cautious in avoiding sending further easingsignals. As a result, interbank liquidity turned a bit tighter last week, increasingthe pressure on the bond market. Bond investors we met recently also spentmore time than before discussing inflation risks.

RMB weakens against CFETS basket: The past three months have been acomfortable period for the RMB, as the dollar index has been weakening.During this time, the RMB has strengthened against the dollar, whileweakening against the CFETS currency basket (Fig 44to 46). In line withwhat we discussed in RMB: The inescapable dilemma (Feb 5), suchmovement suggests that policy makers want currency weakness to supportexports. Weak dollar provides an ideal environment as the PBoC could stillguide the RMB to rise against the dollar, which is key to China’s capital flows.