China Monitor: When Ideology and Markets Collide

Summary

• In this edition of the China Monitor, we answer market questions in relation to the Party Congress.
• How will the market interpret the Party Congress outcome relative to baseline expectations that were already low?
• Are there implications for the zero-Covid policy?
• What are the positive and negative market triggers in the months ahead?
• Where does CNH go now the Congress is over?
• Do cheap Chinese equities have further downside? 
• What are the implications for Taiwan geopolitics and TWD?
• Who is the rumoured new PBOC governor, Yin Yong?

In this edition of the China Monitor, we answer market questions in relation to the outcome of the Party Congress.

Q: How Will the Market Interpret the Party Congress Outcome Relative to Already Low Expectations?

• Expectations before the Congress could best be characterized as 10 more years of President Xi Jinping, and policies that are more of the same going forward.
• But even by this low baseline, the market will be disappointed about the outcome of the Party Congress.
  • At the level of the Standing Committee and Politburo, there were even more of Xi’s people than had been expected last week. They seem to have been selected primarily for their loyalty.
  • With Liu He and Li Keqiang retiring, there appears to be no candidates with the same reform and economic pedigrees in the top decision-making circle.
  • The Party Constitution was revised to include that ‘common prosperity will gradually be realized’, suggesting a difficult future for private enterprise.
• In this context, it is entirely reasonable that the thesis that ‘China is uninvestable’ will keep popping up.

Q: Are There Implications for the Zero-Covid Policy?  

• More of Xi’s people means the end of the zero-Covid policy now becomes exclusively a medical question. Politics and economics will be irrelevant in the debate over ending the zero-Covid policy.
• The weeks ahead may see quarantining for inbound travellers reduced (not scrapped). This decision would improve travel plans for students and business travellers. But if the market rallies on this news, we would fade the move as reduced inbound quarantining would not necessarily impact the broader zero-Covid policy.
• Logic suggests the earliest point of a broad relaxation of the zero-Covid policy could happen in spring. This is the market consensus. But our conviction around that forecast is extremely low. Re-opening could come sooner, and, more worryingly, it could also come later. Perhaps logic has little to do with the decision.

Q: What Are the Next Near-Term Market Triggers?

Unfortunately, we see multiple negative market triggers in the months ahead:

• We see bad news on the mortgage boycott and a spillover from the property freeze. Entering the Party Congress, news about property has (conveniently) been light. But with housing sales still running at negative 30% YoY and land sales off by 40% YoY, the property sector remains in serious trouble. That is, there has been no meaningful rebound yet despite the various support measures in August and September. Ahead, we focus on data on mortgage freezes, possible impact on bank NPLs and LGFV finances, and further price cuts in the primary market for property. This story is not over yet.
• Covid numbers could rise. They have been low in recent weeks. Most likely, the numbers have been kept artificially low heading into the Congress, and we will see more realistic data ahead.
• What will China’s reaction be to the US chips ban? The Congress delayed a reaction, but it will come eventually.
• With Taiwan’s local elections in November, China’s messaging around Taiwan could become more aggressive.

Are there positive catalysts for the market? Maybe a few but no obvious ones:

• Perhaps China will reduce inbound quarantining for travellers, as mentioned above.
• Perhaps Xi will go to the G20 in Bali, opening space for a meeting with President Joe Biden. But his presence is not yet confirmed.

Q: What Are the Implications for CNH?

• Implications are negative on an expectation that PBOC will now allow USD/CNH to rise further. The focus will be on whether the big state banks stop their intervention and whether the fixing is allowed to rise from 7.11 where it has been parked in the last few weeks. Today’s fixing of 7.123 bodes well for that view.
• During Xi’s speech on the opening day of the Congress, he spoke about his pride in China’s large FX reserves. He said this in the context of national security. It suggests PBOC will not want to waste reserves when the dollar is rising against all currencies. The CFETS REER at 99 is still high in the historical range.
• See also this note where we forecast CNH to move to 7.50 after the Party Congress.

Q: Equities Are Cheap – Is There More Downside?

• With China equities already trading at a P/E of 9, valuations are cheap.
• But even with cheap valuations, the market still needs a positive catalyst for prices to improve, and there is no obvious catalyst for now.
• Last week saw $4bn of outflows out of mainland shares, as investors who had entered re-opening trades realized the Party Congress was not going their way. We think these unwinds are not done yet.
• Obviously, an end to the zero-Covid would be a catalyst for an equity rally. But even that would be considered a tactical rally, as the longer-term outlook would not change.
• For now, Hang Seng should underperform SHCOMP, as the latter may find support from state-linked funds. But it is not obvious to us that the new leadership team includes anyone who cares about markets like Li Keqiang or Liu He did.

 Q: What About TWD and Taiwan?

• The language about Taiwan used in the Party Congress was the same as in recent speeches.
• However, two things stood out for us:
  • The Party Constitution was revised to now include a line saying that China ‘will resolutely withhold Taiwan independence.’
  • A new Deputy of the Military Commission was appointed, Zhang Youxia, who is extremely close to Xi. Their connection goes back to their fathers, who were also close.
• With the Party Congress over, we may now see a new, updated response from China to the Pelosi Taiwan visit. Or China may decide to step up its anti-independence rhetoric as there are local elections happening in Taiwan in November.
• Either way, the demand for topside USD/TWD will continue. With CBC giving no signs they are wary about a weaker currency, shorting TWD remains as good a risk/reward as long USD/CNH. Vols are at 10-year highs, but they are unlikely to drop as topside macro hedges will remain common.

Q: Who Is the Rumoured New PBOC Governor Yin Yong?

• Reuters reported yesterday that Yin Yong is the front runner to replace Yi Gang at the head of the central bank.
• The key point here is perhaps that Yong was involved in getting the FX reserves loss under control during the CNY selloff of 2016. He was Deputy Governor of PBOC at that time. His background is similar to Zhou Xiaochuan, and he is trusted by Xi obviously. If he is confirmed in the new role, it would be a good choice.

Bert Gochet is a strategist at Macro Hive, specialising in Emerging Markets strategy. Between 2009 and 2017, he was co-head of global EM strategy with a focus on fixed income and currencies at JP Morgan.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)