MNI CHINA MONEY WEEK: Record Stock-Yuan Correlation To Decline

--Equity Outperformance Vs Yuan Seems Most Likely Scenario

By Stuart Allsopp

     SINGAPORE (MNI) - Chinese stocks and USDCNH are showing a record-high

30-day rolling correlation, currently at 0.95, reflecting the heightened

headline risk facing the country from the trade war with the U.S. Such high

levels of rolling correlation tend not to remain in place over long periods as

seen during previous occasions when the correlation has approached 1.0. A

breakdown in favour of equity outperformance appears the most likely scenario.

     While MNI do not expect a major decline in the correlation as headline risk

will remain elevated in the near term, we do expect to see the correlation head

gradually lower, most likely as the equity market outperforms. Increasingly

dovish monetary policy should act as a headwind for the yuan but a tailwind for

Chinese stocks, particularly given the latter's near-record valuation discount

compared with the U.S. Alternatively, yuan strength and further equity weakness

would likely require a significant hawkish shift by the PBOC, or a dovish shift

by the US Fed, potentially in response to weaker stock prices.

     --HISTORICAL PRECEDENT

     The current period is reminiscent of Q4 2015 when sharp sell-offs in both

the yuan and local stocks gave way to equity market gains and gradual further

yuan losses. Similar to then, Chinese interest rate expectations have fallen

sharply in recent months, undermining support for the yuan but providing a

potential catalyst for equity market strength. Adding to the downward pressure

facing the yuan and upward pressure facing local stocks is the combination of

rising short-term rates in the US near-record valuation premium of US stocks

over Chinese stocks.

     In order for the A-shares/USDCNH correlation to break down in favour of

yuan strength and equity weakness, we would likely need to see the PBOC

undertake a concerted effort to prioritize yuan stability and accelerate the

deleveraging cycle at the expense of equities. Alternatively, any sharp fall in

U.S. stocks, which caused the U.S. Federal Reserve to slow the pace of interest

rate hikes, could undermine stocks globally, including Chinese stocks, and lead

to broad-based dollar weakness.

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

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