China: Fears over tightening overdone
- The 1Q GDP rose to 18.3% YoY from 6.5% in 4Q20 on base-effect and strong sequential momentum
- Major indicators are already above pre-crisis levels
- The outturn is consistent with PBOC’s monetary policy normalisation strategy
- Implication to forecast: GDP is projected to grow by 10.5% in 2021
- Implication to investors: We remain comfortable with CGB duration
First quarter GDP advanced 18.3% YoY, partially due to favourable base effect (-6.8% in 1Q20). On a QoQ basis, it rose by 0.6 %, compared to 2.6% of 4Q. Major indicators exceeded the pre-crisis level (compared to 1Q19). Looking ahead, the growth figures will ease as the base-effect fades, but headline growth will likely be much stronger than the rest of the world.
The supply-side was the prime engine of growth. Production of machineries and health care related products saw more appreciated growth. Automobile production advanced for 12 straight months at 40.4% YoY. Output by both SOEs and POEs held up well. Leading indicators such as the official manufacturing PMI expanded by 13 months in a row. Oil refinery run rate rebounded to 73.6% from 70.6% during Lunar New Year in February, even higher than the pre-crisis level. Power consumption rose by 21.2% in 1Q.
Global economic recovery will boost the export-led industrial production growth. China’s trade surplus swelled to USD117bn in 1Q, 61.1% higher than two years ago. Easing China-US trade tension under the new US Administration should help buttressing export demand.
Retail sales expanded for 8 straight months. Non-necessities such as jewellery shot up 83.2% YoY compared to headline figure, reflecting a buoyant consumption sentiment. F&B also soared by 91.6%. Retail sales will likely be boosted by relaxation of social distancing measures and strong domestic spending amid the absence of outbound travel. Improving labour market condition, with unemployment rate improving to 5.3 % in March from 5.5% in February, also helps. In fact, the services PMI that largely mirror retail sales performance, stayed in the expansion territory for 11 months.
Fixed asset investment (YTD) sustained its uptrend in March. Private investment rose by 26.0%, compared to 36.4% in Jan-Feb. SOEs by investment also increased by 25.3%. Looking ahead, public investment will grow faster due to an enlarging role of the state in the economy under the 14th Five Year Plan (FYP) (see “China Chartbook: Key Takeaway from China’s 14th Five Year Plan”).
Anchoring the FYP, investment will gradually flow from traditional sectors such as real estate and manufacturing to “new-infrastructure”. Investment into the two former industries is expected to slow down due to policy risk (such as the “Three Red Lines”) and the gradual supply-chain relocation to ASEAN countries under the RCEP framework respectively. Meanwhile, R&D, especially basic research, requires further investment. The growth rate of "computer & telecommunication", at 40.4% in 1Q, was higher than the headline FAI. This is particularly beneficial to the Greater Bay Area – the Silicon Valley of the East. (see “Understanding China: GBA integration gathers pace”)
Normalization of monetary policy
Q1 data continued to support monetary policy normalisation. With the recovery picking up speed, authorities recently requested banks to avoid “excessive” lending growth after a surge in debt last year (335.4% of GDP according to Institute of International Finance) stoked bubble risks. PBOC adviser Ma Jun indicated that the growth in the broad money supply in 2021 should be kept at about 9%. This would be down moderately from growth rates so far this year. M2 and aggregate social financing rose 9.4% YOY and 12.3% YOY, respectively, in March. Meanwhile inflation has strengthened as of late, with CPI returning to positive territory at 0.4% YOY last month. Producer price index jumped 4.4% (the highest since July 2018) and looks set to pick up further amid buoyant commodity prices. This would translate into profits for industrial enterprises – condition conducive to a steady stance by the PBOC. As such, we expect LPR to stay unchanged on 20 April.
CGB: Dissipating fears of PBoC tightening
Yet we think that fears over potential monetary tightening this year may be overdone. There are no indications that the PBOC wants to tighten drastically with the 7D repo heading sideways over the past few months. While tax payments and issuances traditionally lead to tighter liquidity, we think that the PBOC can manage these seasonal flows without too much distortions to the money markets. We note that the authorities have several levers that they can pull to manage overheating risks. Accordingly, we remain comfortable with CGB duration, seeing decent carry and roll opportunities in the shorter tenors. We still think longer-term CGB will hold up relatively well even if USD rates take another leg higher over the course of the year.
10Y CGB is the best performer thus far this year amongst the markets we track, registering the smallest yield increase even as global bond markets suffered from a mini tantrum. Even as 10Y US yields rose by about 80bps, 10Y CGB yields have been essentially flat. This underscores a point that we have been emphasizing, that there are tremendous diversification benefits from investing in CGB from a global investor standpoint. Long-term and short-term correlations with UST yields are amongst the lowest in Asia. While the 10Y yield premium offered by CGB has narrowed significantly, the spread is still wide by historical standards, with our Asia Rates Valuation Indicator (ARVI) still showing CGB to be relatively undervalued.
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