Macro Monday:FX reserves rose for the second month

A risk-off week: Last week H-shares slumped 5.2% while A-shares fellanother 0.9% following weaker-than-expected April PMIs readings. Cyclicalsectors such as energy, materials and financials led the decline (Fig 1 & 7).

The commodities frenzy also cooled down. Steel rebar futures prices dropped10% while trading volume contracted 40% WoW. RMB weakened furtheragainst the CFETS currency basket (Fig 46), as the RMB fixing fell 0.9%against the USD last week.

FX reserves increased in April: April FX reserves (released on Saturday)increased by US$7.1bn, rising for the second month in a row. When weexplained why FX reserves slumped by over US$100bn in Dec, we pointed outthat “the most important reason is the renewed depreciation of the RMB sinceearly-November” (What’s behind the sharp drop in FX reserves and the recentRMB depreciation? 7 Jan 2016). Indeed, the reason for the pick-up of FXreserves in the past two months is also straightforward: the strengthening of theRMB against the dollar during this period, which is in turn driven by the broadweakness of the dollar index. In other words, no matter due to tacit policycoordination or just dumb luck, the weakened US dollar has greatly eased thepressure on RMB and capital outflows from China. Down the road, if the USDstrengthens, the RMB could depreciate again against the dollar and capitaloutflow will pick up as well. But the markets will gradually get used to the upsand downs of FX reserves and stop making a fuss like earlier this year.

The PBoC pledges prudent monetary policy: The PBoC struck a balancedtone in the 1Q16 Monetary Policy Report released last Friday, suggesting thatpolicy has turned neutral after the credit binge in 1Q16. While assertingcontinued support to the economy, the PBoC also cautioned against therecent pickup in inflation and rising home prices. The latest home prices datashowed that the price rally is spreading to tier-2/3 cities. Meanwhile, the PBoCalso announced last week that going forward it will conduct PSL with policybanks every month to fund infrastructure and social housing investment. Tobe sure, we don’t think it implies an opening of tap. Instead, the PBoC justwants to make the funding supply to infrastructure projects smooth andregular. The seasonality of commercial bank loans is one reason why thecredit data in 1Q16 is so embarrassingly strong. More broadly, over the pastyears, policy banks especially the China Development Bank (CDB) haveplayed an increasingly important role in provide funding to infrastructureprojects. In 2015, the CDB accounted for 18% of new bank loans, comparedwith 6% in 2014. In a deeper sense, it shows the nature of China’s monetarypolicy which is highly fiscal driven. One could never really tell monetary andfiscal policies apart in China.

Exports declined again in April: Trade data released on Sunday show thatexports (in USD) fell 2% yoy in Apr while imports slumped 11%. The data isconsistent with our view that the positive reading in Mar was misleading dueto the upward bias by base effects. We believe the exports outlook remainschallenging, given the sluggish global economic growth. As such, the PBoCwould continue to prefer a weakening RMB against the currency basket (Fig46). Meanwhile, the slump in imports despite the recent commodity pricesrally points to subdued domestic demand. That said, imports from HKcontinued to defy gravity, surging 203% yoy in Apr after rising 116% in Mar.

No wonder the HK authorities have recently strengthened scrutiny on faketrade activities.