MNI CHINA MONEY WEEK: PBOC Policy Turning Pro-Cyclical

--China Equity Market Breakout Reflects Policy Dynamics

By Stuart Allsopp

     SINGAPORE (MNI) - The yuan's rally in the face of the continued U.S.-China

monetary policy divergence reflects a large sentiment shift, as fears over a

devaluation in response to a trade war subside. 

     It has also shifted the PBOC into a pro-cyclical policy stance, with the

positive impact of any improving trade relations likely to be amplified by

further easing. This week's equity market breakout looks to be a rational

response to such policy dynamics.

     Analysts appear unanimous in their expectations for further PBOC easing

over the course of 2019, with recent yuan strength seen as providing the PBOC

with a window of opportunity to ease without creating unwanted inflationary

pressures or triggering capital outflows.

     China's dovish monetary policy tilt gained traction this week after the

PBOC injected a record CNY1.16trn via OMOs. While part of the injection is aimed

at addressing funding shortages ahead of the Lunar New Year, the bank appears to

be guiding interbank borrowing costs down in lieu of official interest rate

cuts, reflecting an increasingly dovish stance -- as an op-ed article in

Friday's Securities Daily noted.

     This week's increased liquidity injections via OMOs follows a number of

easing measures undertaken in the last month or so, including the RRR cut,

expanded eligibility of lenders for reserve ratios cuts, and reduced funding

costs via the Targeted Medium-term Lending Facility. The results have been seen

in the fact that interbank rates have spent most of the month below the cost of

the PBOC's 7-day reverse repo rate. This has also helped to send 10-year CGB

yields to fresh cycle lows.

     --YUAN SENTIMENT SHIFT

     We see two main takeaways from the current dynamics in China's financial

markets. Firstly, the fact that the yuan remains in its appreciatory trend in

the face of the growing divergence between U.S. and Chinese monetary policy

reflects a shift in sentiment towards the yuan. 

     It appears as though yuan weakness in H218 overshot amid fears of a trade

war, with hedge fund positioning turning deeply bearish on the currency and

option markets showing elevated positioning for a devaluation. Recent yuan gains

reflect a paring back of these fears.

     --PROCYCLICAL POLICY

     Secondly, if the yuan is pricing out the likelihood of an escalating trade

war, and recent yuan gains are raising expectations of further easing, the

PBOC's policy appears to have turned pro-cyclical. A continued thawing of trade

relations would likely allow further easing, with both of these factors helping

to boost economic growth at a time when expectations are growing increasingly

pessimistic. 

     This looks like good news for local equity markets, with the CSI seemingly

poised to close the week clear of down trendline resistance from the September

highs to mount a bullish trend change.

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

[TOPICS: M$A$$$,M$Q$$$]