China Economy:6.82gives way,as US yields and the DXY keep rising

Fundamentals: A better-than-expected PMI number, at 51.2 for October, had raised expectations for activity indicators for the same month. But once again, reality has not lived up to expectations. Today’s data release shows that industrial production was up 6.1% YoY for October, unchanged from September. Retail sales were up 10.0% YoY for October, notably weaker than the 10.7% YoY rise seen for September.

    Ex-rural FAI gained 8.3% YoY for 10M16, just a tad higher than 8.2% YoY for 9M16. Earlier on, external trade numbers were not exciting either. Exports and imports fell 7.3% and 1.4% YoY, respectively. Loan data was equally soft. Aggregate social financing came in at only CNY896bn. New loans were just CNY651bn, of which 75% was household long-term loans.

    Overall, the underlying fundamental picture does not bring us to any inspiring conclusion. This should not come as a surprise. Without sustained signs of stabilisation in terms of money flows and currency, the economy cannot stabilise and bounce back in any meaningful manner. There were a few months when the market didn’t seem to care about these factors. However, as the CNY has continued to tumble and the balance of payments data for 3Q16 shows much larger outflows (see New MOF chief; 3Q16 balance of payments, on 7 November), there is good reason for the market to reassess the whole situation again, in our view.

    Daiwa held 2 investment conferences last week, one in Hong Kong and another in Tokyo. The author attended both. Investors were once again worried about CNY depreciation. Many were surprised by the speed of the depreciation post China’s admission to the IMF’s special drawing rights (SDR). Trump’s presidential victory has added a new layer of risk and uncertainty, especially for the CNY. The USD has clearly rallied after the election, as the market now expects Trump’s fiscal stimulus to drive US inflation higher. US 10-year yields have surged to 2.22%. Higher US yields are generating even more pressure on money outflows from China.

    Hence, the CNY is finding itself in a precarious situation. In this context, the PBOC has today fixed the CNY parity rate at 6.8291, 176 pips weaker than Friday. This move suggests to us that the PBOC is in no serious mood to defend 6.82, while many market commentators had expected it to do so. In our note on 28 October, Is 6.82 going to be a support?, we argued that this level was likely to give way soon.

    The DXY index is now just a tad below 100. It tested and failed to break this level in March and December 2015. A breakout at this point would be technically significant. If this level were to be cleared, it should easily open up further upward momentum. The real challenge would then occur for the CNY. Our 7.50 year-end forecast has been held for more than a year. It may look a little far-fetched at this point. We are leaving it unchanged however, exactly because of these reasons.