CHINA MONEY WEEK: It's Getting Harder To Be A Yuan Bull

--PBOC's Bank Recap Points To Major Dovish Shift

By Stuart Allsopp

     SINGAPORE (MNI) - After turning bullish on the yuan against the dollar back

in early December, the currency has appreciated 2% while the real effective

exchange rate has risen back to six months highs, even as the PBOC has shifted

to an outright dovish policy stance. With Beijing seemingly doing away with its

goal of reducing leverage in favour of supporting credit growth amid the ongoing

economic slowdown, it is getting increasingly difficult to justify further

strength.

     Yuan gains over the past few months seem to have been driven by a reversal

in extreme bearish sentiment that prevailed in H2 amid fears over a full-blown

trade war. While this threat has somewhat, although not entirely receded, easing

tensions has allowed the PBOC to throw caution to the wind regarding its easing

policy, which may increase the downside pressure on the yuan over the medium

term.

     --CAN KICKING

     Last week's announcement by the PBOC that it will allow China's primary

dealers to swap their holdings of perpetual bonds for central bank bills, and

directly use those bonds as collateral to access PBOC liquidity operations, is a

clear sign that Beijing is not willing to allow a shift towards a system in

which banks operate according to market forces and away from being policy arms

of the state. 

     While the indirect bank recapitalization may help to support near term

growth by easing a constraint on credit supply, China's growth slowdown is

likely more structural in nature and will not be solved by increased liquidity.

     An MNI Exclusive story today noted that the PBOC's moves to boost lending

by recapitalising banks will have limited impact on credit expansion without

more fiscal stimulus and a partial rollback of rules imposed during a drive to

limit leverage according the central bank and government advisors (see 'MNI

Exclusive: Bank Recapitalisation Not Enough: Advisors). This raises the prospect

of further stimulus measures, particularly on the fiscal side, which should

further undermine the appeal of the yuan.

     The U.S. Federal Reserve's pivot to a neutral stance at Wednesday's meeting

should be dollar negative all else equal, but monetary conditions remains

relatively tight in comparison to China. The 10-year bond yield spread between

the U.S. and China still implies USDCNH should be trading higher than current

levels. The recovery in oil prices should also put upside pressure on Chinese

inflation relative to the U.S., supporting U.S. real yields on a relative basis.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

[TOPICS: M$A$$$,M$Q$$$,M$$FI$,MN$FI$,MN$FX$]