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China: Not Ready Yet

06/13/2011

In a previous blog entry, "Baseball Season of Frustration 2," I suggested some potential "villains" and "heroes" for the ending of the current capital market drama. China is confidently penciled on the hero side of the ledger. The current monetary and fiscal tightening measures being enacted by the People's Bank of China will end in the second half of 2011. When those measures do end, reacceleration in China's contribution to global growth will occur; however, Chinese reacceleration is "not ready yet."
 
Last week's data was consistent with continued tightening equal to "not ready yet:"

  • Exports growth slowed, from 29.9% to 19.4%
  • Trade surplus rose, from $11.42 billion to $13.05 billion

The upcoming week provides the release of the following economic data from China:

  • CPI expected to rise, to 5.5% from 5.3% (government target is 4.7%)
  • Industrial production expected to fall, from 13.4% to 13.1%
  • Retail sales expected to fall, from 17.1% to 17.0%
  • Fixed asset investments expected to fall, from 25.4% to 25.2%
In the fixed income market, the 10-year Chinese government bond and the U.S. 10-year Treasury traded to a 6-month high. The China 10-year bond widened to a 92-basis point premium (Fig. 1.1). That yield premium will support further capital inflows and Chinese currency appreciation.  Combining the inflows, positive growth outlook, and inflation uptick, I expect appreciation in the China yuan to accelerate in the coming months. Last week, the yuan traded as high as 6.4744 per U.S. dollar, a 17-year high. I expect further appreciation toward 6.250 per U.S.  dollar. Further yuan appreciation (Fig. 1.2) is an extremely favorable condition for the global capital markets to return higher in the second half.
 
China:  A potential "hero" but "not ready yet"
 
Fig. 1.1 China 10-Year Government Bond vs. U.S. 10-Year Government Bond

Source: Bloomberg
 
Fig 1.2  China Currency, 1/16/09 - 06/10/11

Source:  Bloomberg

 

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