MNI CHINA MONEY WEEK: Goldilocks Theme Shows Signs Of Ending

--Pro Cyclical Policy Raising The Trade War Stakes

By Stuart Allsopp

     SINGAPORE (MNI) - The return from the Chinese New Year break has seen a

series of mixed messages on the U.S./China trade talks front, along with a solid

beat in China's January trade figures. 

     The divergence between the equity and bond markets reached extremes earlier

in the week as the simultaneous equity and bond surge continued, although there

are some signs that the goldilocks scenario of rising equity and bond prices is

becoming somewhat stretched. 

     Since the start of the year the main narrative in China's financial markets

has been increased optimism on the trade talk front, which has seen the yuan

steadily appreciate, allowing expectations of fresh easing by the People's Bank

of China to intensify, in turn triggering a major bullish break in equity

markets. 

     --BILL SWAPS

     We have long held an upbeat view on Chinese stocks, buoyed by the

combination of low equity valuations and the PBOC's determination to support

financial conditions, which was most clearly displayed by the recent Central

Bank Bill Swap arrangement which effectively amounts to a backdoor bank

recapitalization.

     The key risk to this view of course is a failure of trade talks to yield a

favourable outcome. Not only would this take the wind out of the sales of the

equity market but it would also bring into question the extent to which the PBOC

could continue to ease policy. 

     As we alluded to a few weeks ago, the PBOC is now operating with a pro

cyclical monetary stance, where positive external dynamics provide support to

the yuan and give the bank room to ease. 

     This clearly leaves open the possibility that a failure to reach a

consensus on trade negotiations could trigger fresh yuan weakness and force the

PBOC into paying more focus to the downside risk to the yuan than the upside

risks to the economy. 

     That said, with Chinese equity markets now showing broad based

participation, helped by this week's surge in small cap stocks, we continue to

see Chinese equity outperformance from a global perspective. In contrast, we see

the risk to bond yields as weighted to the upside. 

     Against a backdrop of an equity market rally, bonds could come under

pressure from either a continued improvement in risk appetite which raises

equities further, or from a forces hawkish shift should yuan weakness resume. 

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

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