Macro Monday China:RMB weakened to 8-year low as dollar hit 13-year high

Markets dominated by “Trumpflation trade”: With the unexpected USelection result, markets now are dominated by the expectations of reflationand fiscal expansion. US equities have rallied strongly with financialsoutperforming. US 10-year Treasury yield rose to a one-year high of 2.35%(Fig 42), while the dollar index hit a 13-year high. China markets clearly feltthe impacts. Last week, the RMB fell 1.1% against the US$ to 6.89, thelargest weekly depreciation this year. Meanwhile, China’s 10-year Treasuryyield rose to 2.9%, the highest since Jun. Equities were also under pressure.

H-shares fell 0.9% last week and A-shares ended a 5-week winning streak.

Faster depreciation on reduced capital outflows: The pace of RMBdepreciation has accelerated notably recently. Probably one important reasonis the reduced pressure of capital outflows in Oct. Data released last weekshowed banks’ net FX sales were US$15bn in Oct, much smaller thanUS$28bn in Sep. The PBoC’s FX purchase position, another measure ofcapital outflows, fell by US$40bn in Oct vs. a US$51bn decline in Sep.

Therefore, although the headline FX reserves dropped more in Oct (US$46bnvs. US$19bn in Sep), it should be mainly due to unfavorable valuation effects.

The ease of capital outflows should be largely due to a larger trade surplus(US$49bn vs. US$42bn in Sep) and lower seasonal FX demand in Oct. But itmight have also emboldened the PBoC to allow for faster depreciation in thepast couple of weeks.

Capital outflow pressure lingers: Data from China banks showed that inOct, only 58% of FX received by their clients were converted into RMB,compared to over 70% before Aug 2015. This suggests that domesticresidents/companies prefer to hold foreign currencies in anticipation of furtherRMB depreciation ahead. To be sure, the market is far from the panic modeseen in Aug 2015 and the beginning of this year. However, the depreciationexpectation has certainly become more entrenched given the recent RMBmovement. The outflow pressure would persist with such expectations.

Bond market under pressure: Interbank liquidity tightened again last weekas repo rates edged up (Fig 39). China’s 10-year Treasury yield hit thehighest since Jun. Three headwinds are behind that. First, the “Trumpflationtrade” has pushed up bond yields globally and China is no exception. Second,investors are expecting the PBoC to be less accommodative given the latestPolitburo meeting emphasized “preventing financial risks” (our comment).

Third, the inflation expectation is picking up. We expect the toughness tocontinue till 2Q17, when the property down-cycle starts hitting the economy.

At that time, the current reflation trend could peak and monetary policy couldease again.

Property tightening taking effect: China released Oct activity data last week(our comment), in line with expectations and pointing to 6.7% GDP growth(again!) in 4Q16. The NBS 70-city home prices data released last weekshowed a notable slowdown in home prices growth after 20+ cities hadtightened policies in early Oct. 70-city average home price rose 1.1% mom inOct, down from 1.8% in Sep (Fig 31). Moreover, according to the NBS, 14 ofthe top 15 cities had weaker home price growth in the second half of Oct, and7 of them even saw sequential home prices decline.