Macro Monday-RMB:Volatility or trend depreciation?

H-shares retreated on weak sentiment: Last week H-shares pulled back 3%.

Sentiments were weighed down by weaker RMB and trade data. On thecurrency front, USD/CNY broke above 6.70 after returning from the week-longnational holiday. For the whole week, onshore RMB fell 0.8% against the USD,while the dollar index rose 2.8% in the past two weeks.

Weaker RMB: Volatility or trend depreciation? The weaker USD/CNY lastweek has rekindled concerns about RMB, as it’s in line with the existingspeculation that the PBoC would allow more depreciation after the SDRinclusion on 1 Oct. However, the weaker exchange rate set by the PBoC ismore likely due to the broad strength of the USD, as the dollar index nowstands at a 7-month high (Fig 45). Indeed, if the dollar rose more in the run-upto the Fed hike in Dec, the RMB could further weaken against the USD in thenear term. But the trajectory of the USD is highly uncertain so we maintain ourend-2016 USD/CNY forecast of 6.6, which was made last Sep. Most likely,the USD/CNY will end this year in the range of 6.6-6.8. Our end-2017 forecastis 6.4, while the current market consensus is around 7.2. However, we believethe RMB will see higher volatility but not a trend depreciation. While the maintask for the PBoC in 2016 is to fight capital outflows, the next battle would bewith the depreciation expectations.

Housing market: Supply mismatch or bubble? A recurrent debate in thepast decade is whether China’s housing sector is in a bubble or over-invested.

In our latest thematic report on the property sector, we argue that the problemis more about a misallocation of land supply. Cities with population inflowshave housing under-supply and thereby soaring prices, but the rest havehousing over-supply and thereby huge inventory. The bubble vs. misallocationtheories have vastly different policy and investment implications. For instance,in the previous down-cycle in 2014, if one believes in the bubble/overinvestmentstory, one should avoid holding any China properties and expectlong-term stagnation in the sector. But if the mismatch story is correct, oneshould enter cities with under-supply but avoid cities with over-supply. Inshort, China’s housing problem is a misallocation of land across variousregions. More broadly, we believe most economic problems are misallocation.

For instance, in our thematic study on debt, we argue that debt in China ismainly a misallocation of credit between the public and private sectors.

Trade growth still sluggish but PPI deflation ended: Sep trade datareleased last week weighed on the markets as the data came in weaker thanmarket consensus. Exports (in USD terms) fell 10% yoy (Aug: -3%) andimports dropped 2%. On one hand, it’s not as bad as it looks, as the reboundin Aug was mainly driven by two more working days. However, it still suggeststhat the global demand is lacklustre. In 4Q16, exports growth could remainsluggish in negative territory, while imports growth could improve further onhigher commodity prices. Meanwhile, Sep inflation data released last weekwas surprisingly strong. It’s even so for us, who are among the most positiveon the reflation cycle (Thoughts on earnings cycle: A new start? April 2016).

In particular, PPI turned positive in Sep at 0.1% yoy, ending a 54-monthstreak of deflation (Fig 17). The escape of deflation bodes well for nominalGDP and corporate earnings growth, underpinning our strategist’sconstructive view on China equities (Inflation Nation, Oct 2016). However, CPIinflation edged up to 1.9% yoy (Aug: 1.3%), which further lowers the chancefor monetary easing in the near term.