CNY rates should stay anchored across the curve. China’s August data suggest that a K-shaped economy, with resilient external demand offsetting persistent weakness in the domestic drivers. Industrial supply continues to outpace consumption and investment demand. Growth of industrial production accelerated to 5.2% from 4.5% in July. In contrast, contraction of FAI widened from 6.7% YoY YTD to -7.2%, and growth of retail sales slowed to just 0.4% YoY from 0.6% (see our macro report).
There are two key implications. First, diverging external and domestic sector performance is translating into higher national saving and CNY liquidity. In other words, the current account inflow is being translated into domestic investment. Excess savings should continue to support demand for domestic financial assets. More importantly, resilient exports are encouraging exporters to convert USD receipts into RMB. As the CNY continues to appreciate, exporters have greater incentives to retain RMB to preserve the value of their revenues. FX deposit growth has already slowed from 25.0% YoY in January to 17.3% in August. The rising CNY FX hedge ratio further points to stronger demand to sell USD receipts forward and buy CNY, reinforcing both CNY appreciation and domestic RMB liquidity.
Second, excess supply is curbing inflation momentum and pushing up real interest rates. Relative to other major economies such as the US and Japan, China’s real policy rate, measured against the 1Y LPR, remains elevated at around 2.2%, weighing on credit demand. With loan demand remaining weak, banks with excess liquidity have greater incentives to allocate funds to bonds.
Against the lacklustre macro backdrop, the belly should be the sweet spot. The 5Y sector is long enough to reflect the medium-term growth, inflation and liquidity outlook, but less vulnerable than the long- end to swings in term premium.
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