Macro Monday:The most important questions

Markets rallied for the second week: Last week H-shares rose 2.3%, led byfinancials. Sentiment was upbeat on the positive macro outlook and risingmoney inflows from the mainland. Average daily turnover in the HK market rose18% WoW to a one-and-a-half-year high (Fig 6). Meanwhile, the RMB gained0.3% against the US$ as the dollar weakened. We published an 11-page reporton our conversations with US investors during our recent marketing trip.

In the note above, we discussed the most important questions now comparedwith 12 months ago. Back then, they were whether China would have (or hadalready had) a hard landing, whether capital outflows would run out of controland whether China would continue to be mired in deflation. Now the mostimportant questions are when the cyclical turning point comes, the inflationoutlook and how politics (especially the US-China relationship and the politicaltransition) could impact the markets.

For us, the questions for now are harder to answer than those 12 months ago,partly because they are more data-dependent but China is still under a datavacuum due to the CNY holidays. In any case, when we called the start of anew earnings cycle (link) last April, it was based on four emerging signals:property, PPI, inventory and oil. While it’s almost certain that earnings growthwould accelerate further in 1Q17, the future path still largely depends on thesefactors, especially the property market. The pace of slowdown at the nationallevel is not very clear now, though in the past few months, higher-tier citieshave slowed sharply but lower-tier cities have held up.

Indeed, policy makers might be perplexed by these questions too, as they aresending out mixed signals. In the 4Q16 Monetary Policy Report released lastFriday, on one hand, it said for the first time that the monetary policy stance is“neutral” and also put much more emphasis on inflation and asset bubbles thanbefore. On the other hand, it also shows no intention to tighten moreaggressively such as hiking the benchmark rate. Moreover, last week, thedeputy Governor of the PBoC, Yi Gang, said the new loans number in Jan,which is perceived as a strong reading by the market, is a “very suitable one”.

Strong macro data in Jan but not sustainable: Regarding the data releasedlast week, Jan inflation and credit data both came in robust. However, it isworth noting that China’s data in Jan/Feb can be highly volatile and distorted bythe CNY holiday. CPI inflation rose to 2.5% yoy in Jan, but could drop toaround 1.5% in Feb. Overall, we expect 2017 to be a year of modest reflation,but the pressure could ease after 1Q17 on weaker demand and a higher base.

We also see the strong credit growth in Jan as unsustainable due to slowingproperty sales ahead. Overall, while in Jan the economic data (including trade,inflation and credit) are all encouraging, we do not want to read too much intothem but instead will put more weight on the development in the propertymarket in the coming weeks.

RMB gained support from improved outflows: The RMB is mainly driven bytwo factors: the US dollar and China’s capital flows. The PBoC’s FX purchasedata and banks’ FX settlement data released last Friday show less capitaloutflows in Jan. This is contrary to previous market concerns, which expectedlarger outflows due to the new US$50k quota. In particular, outflows under theservice trade, which mainly reflect individuals’ FX purchases, narrowed in Dec.

This suggests tightened capital controls are taking effect. In our 2017 outlook,we expressed a highly anti-consensus view that the era of one-waydepreciation had ended; the RMB would see two-way volatility in 2017 and endthe year without depreciation.