Macro Monday:The next battle for the PBoC

China stocks rebounded as the Fed stayed put: Last week H-shares rose2%, while property stocks outperformed the most on strong home price data.

A-shares also edged up 1%, but the sentiment remained subdued with dailyturnover falling to the lowest since Nov 2014 (Fig 12).

The next battle for the PBoC: Last week, we published a report on the longtermoutlook for the RMB (How to think about the RMB?). Against theconsensus, which expects the RMB to have a trend depreciation, we forecastthe USD/CNY to end 2017 at 6.4 and appreciate more in the long run. Thereport has received a lot of push-back, just like many of our reports related tothe RMB. For instance, on the same day of the RMB devaluation last Aug, weforecasted that the depreciation would be less than 5% from then on to theyear-end (link). In our 2016 outlook (link), we forecasted the USD/CNY to end2016 at 6.6. Earlier this year, we forecasted that capital outflows are easilymanageable as hot money has largely gone (link). Admittedly, the dominantexpectation is a trend depreciation for the RMB. With that, the RMBinternationalization has backtracked as the RMB deposits in HK have alreadydropped to RMB670bn from the peak of RMB1tn in Dec 2014. For theChinese government, which has spent tons of effort on things like the SDRand AIIB, it has so much to lose from the abortion of RMB internationalization,which is also important to One-Belt-One-Road. Therefore, the next target forthe PBoC has to be the prevalent depreciation expectations.

How to win the battle with depreciation expectation? Over the past year,the RMB has had a slow depreciation and limited volatility. Since most peopleare trend-followers, no wonder the depreciation expectation is so prevalent atthis moment. To win the battle with depreciation expectation, the PBoC needsa new strategy, which is to guide the RMB stronger while increasing thevolatility. Under the new strategy, the market knows the long-term direction ofthe RMB but not the short-term trading band. Therefore, when the RMB fallsto some extent, speculators would expect it to reverse and start buying. Bydoing so, the PBoC essentially changes the one-way expectation by winningallies among market participants. Over time, the PBoC could graduallyincrease the band and ultimately let the RMB be determined by market forces.

To be sure, at the beginning of the year when lots of people forecasted a oneoffdepreciation, we argued that the best strategy for the PBoC in 2016 is astable RMB (link), because at that time the credibility for the PBoC was notenough and capital outflow pressure was high. It turns out that a stable RMBis also the actual strategy adopted by the PBoC. However, the situation haschanged as capital flows have eased. So it’s the time to move on.

Property prices and exchange rate: One push-back to our positive RMBview is that the PBoC has to depreciate currency to keep property prices nearcurrent level. We do agree that rising home prices could cause more Chineseresidents to sell their property in China and buy foreign assets. However,there are other and probably more important channels to influence the RMB,such as trade balances and economic growth. That’s why China’s homeprices have increased rapidly over the past 15 years but the RMB has alsoappreciated. Moreover, while in this round of property up-cycle, home pricesdo increase fast in certain cities, but the rise is not a broad-based one. Overthe past 12 months, 48 out of the 70 biggest cities had home price growth lessthan 5%. As such, if the property market could cool down in the next sixmonths as we are expecting, the negative impact on the RMB will be limited.