China Monitor: March to Be More Constructive for the China Rebound Trade

Summary

• February was a bad month for China risk assets. January’s entire rally in CNH and Hang Seng unravelled. But A-shares remained near the highs.
• March should be better. We will see the first economic activity data that is truly post-Zero Covid. Also, we expect that the messaging from the ‘Two Sessions’ will be pro-growth and less about ideology.
• Strategy:
  • We still hold long A-shares (SHCOMP), targeting 3,600.
  • We still hold short USD/CNH where we were originally targeting 6.65. But we are now close to our stop (7.00).
• The main risk to being long China is US-China geopolitics. But there are reasons to be less gloomy on this front.

January’s Rally Unravelled in February

Since the ending of Zero Covid, China risk assets have been trading in what is called a ‘vacuum of economic data’. Because of the Lunar New Year, there is hardly any useful activity data being published during January and February.

It is a shame. High frequency indicators such as mobility numbers and housing sales, as well as soft indicators such as PMIs, suggest that China’s economic recovery this year is quite strong. But we will not know if this is true until mid-March when we see actual IP, retail sales and investment data being published (for the combined month of January and February).

Take CNH as an example. In the absence of hard economic data, USD/CNH has traded in line with the stronger broad dollar, and on worsening geopolitics such as the spy balloon, US threats over lethal weapon supply to Ukraine, etc.

What was a nice rally for the renminbi during January (from 6.90 to 6.75) has entirely unravelled during February (from 6.75 to 6.96). Crucially, though, there do not appear to be China-specific fundamental reasons for renminbi to weaken, unless US rates ramp much higher still and the dollar keeps rising.

A similar dynamic played out in Hang Seng and foreign-listed China shares, with February losses erasing January gains. Note that onshore A-shares (i.e., SHCOMP Index) are still near the high. Mainland investors have by and large not taken profit on their longs.

March Promises a Better Risk Environment

What changes in March so that we can expect a better risk environment for China?

First, the two sessions will kick off from 4 March. This will be when China’s new leadership comes fully into place. I expect the policy signs to be pro-growth and downplay ideology. We expect the annual growth target to be set at 5.5%, i.e., somewhat higher than the consensus of 5%. This slightly higher target will send a signal that policies will be geared towards economic recovery.

Second, activity data for January and February will be released in the middle of the month (15 March). We already know that high-frequency mobility data and soft indicators such as PMIs have risen substantially since Zero Covid was lifted. But the hard activity data such as IP, retail sales, and investment will hopefully increase the market’s confidence that the economy is on the right track.

Finally, what about geopolitics? While I don’t think US-China tensions will disappear, it strikes me that China is trying to avoid an all-out clash with the US this year. As an example, China has not really reacted to various US sanctions that have been announced in recent months. Also, to some extent, I see the visit of Wang Yi to Europe and Xi’s meetings in Bali as efforts to ‘reach across the aisle’. At a time of economic weakness, it is probably not in China’s best interest to fan the geopolitical flames. Having said that, if China were to deliver lethal aid to Russia for the Ukraine war, all bets are off.

Trading Strategy and the Risk of CNH Breaking 7

What’s the trading conclusion? I still have a short USD/CNH entered in the early days of 2023. I still believe that this trade recovers, but to be fair my stop of 7.00 is coming closer.

I also still expect A-shares to rise further. They are still cheap when compared to Hang Seng and US-listed China shares. If March plays out as we expect, then capital inflows into China will support CNH and domestic investors will add to their A-share longs.

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.

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(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.)