China: Outlook for 2017 – Deutsche Bank

Research Team at Deutsche Bank, suggests that the Chinese government faces a policy dilemma in 2017 and DB believes it would be able to achieve the 6.5% growth target with strong fiscal easing in 2017.

Key Quotes

“But this requires further credit expansion, which would exacerbate the risk of property bubble and intensify capital outflows. We anticipate CPI inflation to pick up, from 2.1%yoy in Oct 2016 to averaging 2.5% in 2017. We expect FX reserves to fall to US$ 2.8trn in 2017 and USD2.4trn in 2018, and USDCNY to depreciate to 7.4 by end2017 and 8.1 by end-2018.”

“Main risks: Property bubble, capital outflows and RMB exchange rate, and a potential US-China trade war are the main risk factors to watch out for in 2017. We also see macro risks rising beyond 2017, with a 50% chance that growth will drop below 6% for a full year sometime between 2018 and 2020.”

“Strategy:

Fixed income strategy: We expect rising volatilities in CNY rates market to generate more interesting trading and investment opportunities in 2017. We consider eight risk factors in assessing the duration, curve and volatility risk of CNY rates. In 2017, we expect 7D repo rate to rise towards 2.5-2.75%, 10Y CGB yield will trade between 2.85-3.40% range, 10Y CDB yield at 3.20-3.75% range and 5Y IRS/NDIRS rates in the 3.00% - 3.8%.

• We recommend to trade the range through the year while be defensive on duration exposure in Q2 as we expect the risk of rates correction/overshoot to be particularly acute in Q2 on government debt financing kicks off after the NPC in March and equity market sentiment tends to be strong.
• We see steepening as the key risk to both the IRS curve and the CGB curve as the 7D repo rate has adjusted towards our forecast range, and further bearish move would be attributable to duration supply and risks of further policy tightening. For similar reasons, we expect bond rates and curve volatility to rise in 2017.
• We think liquidity risk, correction in risk free rates, upcoming credit events and a potential slowdown of WMPs growth (such demand was the key demand support for the corporate credit market in 2016) makes the corporate credit market more exposed to a correction.
• We forecast the 5Y credit spreads will widen by 30bps, 50bps and 90bps for AAA, AA and A rated names and lower rated corporate credits to underperform. We expect the credit market to underperform the rates market in H1 2017 and recommend asset allocators to maintain credit exposures to highly rated names in H1.”

“For FX, we continue to expect RMB weakness against the USD into 2017, driven by four key themes – (1) the financial trilemma; (2) further asset diversification by domestic investors; (3) rising concerns over China’s ability to manage RMB depreciation; and (4) worsening trade tensions between the US and China. All in all we still prefer being long on USD/CNH (targeting a move to 7.0 by early next year) and paid on the curve (with a target on the 3Mx12M spread of 1,800).”