CNY Rates: Stimulus withdrawal
- The PBoC has already normalized policy
- The settings will be neutral with a hint of tightness
In relative terms, the People’s Bank of China (PBoC) has been one of the most aggressive in terms of normalizing monetary policy. Short-term and long-term CNY interest rates are already back to pre-COVID-19 Pandemic crisis levels. However, judging by the actions and comments by the authorities, a further modest rise in rates cannot be ruled out. There are several points to keep in mind as we formulate the strategy for onshore rates.
CNY interest rates tend to move according to how the economy is performing. Clearly, this is due to the PBoC’s response function. While the Fed and most other central banks are worried about growth risks, the PBoC appears to place a higher weighing on inflation and financial stability. Moreover, PBoC did not do quantitative easing (buying of government bonds), partly accounting for why CGB yields did not fall as much during the acute phase of the Pandemic crisis in 1Q and 2Q. Accordingly, when China contained the virus and the economy picked up subsequently, the pace of tightening (via the liquidity route) proved to be rapid, with the 3M SHIBOR back at 3.1%. The flatness of the yield curve (2Y/10Y) suggests that policy settings already have a hint of tightness.
We think that the CGB curve will level shift higher (keeping to the relatively flat profile) with 10Y yields drifting towards 3.4% before stabilizing. Notably, bear markets in the CGB space can last beyond a year. If China growth gets positive impetus from a bounce in the global economy, overheating risks may materialize. If so, the PBoC should be more responsive than DM peers. That said, if real rates stay relatively high for China, the currency should hold up, providing a tailwind for foreign investors. In any case, with the PBoC far along on normalization and CGB already offering decent yield, total returns (in CNY terms) for 10Y CGB would still be positive even if yields rose to 3.5%. By contrast, we expect total returns for 10Y UST to be modestly negative for 2021.
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