China Update and Preview

The combination of broad based US dollar weakness, especially pronounced since the start of the month, and expectations that China's export contraction is bottoming is helping send 12-month non-deliverable forward to its best level in 3 months this week. The PBOC has been fairly generous in their money market operations, providing net injections and keeping the key 7-day repo rate soft (it fell 12 bp today to 1.54%).

Like the forwards, the spot yuan has strengthened in recent days, but remains in such narrow range that for all practical purposes it is probably best conceived as fixed. From high to low this year against the dollar is slightly more than 0.66%. Yesterday the dollar was at its lowest level against the yuan since early June. The dollar firmed ever so slightly today, in line with its consolidative tone.

One of the upward pressures on the yuan may be stemming from expectations for the slew of economic data in the coming days that should show that the economic recovery is strengthening. The key data in this regard will be industrial output (Sept 10), exports (Sept 11) and new loans (sometime over the next several days).

Industrial output for August is expected to continue to improve. The year-over-year rate will likely rise by 11.8% after a 10.8% pace in July. This would be the strongest pace since last Aug.

China's Aug trade balance is expected to have grown sharply in Aug to $13.6 bln, nearly 30% larger than in July. A report close to the consensus would be the best in since March's $18.6 bln surplus and would be the second consecutive increase. China is a large exporter and also a large importer. The implosion of exports appears to have bottomed in the first half, along side world growth. In July Chinese exports were 23% below year ago levels. The consensus expects the contraction pace to moderate to -19%, which would be the best reading since March.

Imports also imploded, but bottomed before exports. This may be a function of China stockpiling commodities. In January Chinese imports were off 43% year-over year. In August, the consensus expects the pace has moderated considerably to -10.5%. In July imports were off 15% year-over-year.

After tripling in the first half, new yuan loans slowed considerably in July and are expected to slow further in August. The greater the slow down the more generous the central bank may be in its open market operations.

There are a couple of other reports that may garner attention but are unlikely to contain as much new information. For example, retail sales will be reported on Sept 10, but is not a really meaningful report. Remember China counts as retail sales when a good is shipped to the retailer not when the consumer buys it, which is what other countries regard as retail sales. Inflation figures, both producer and consumer prices, are due as well. The year-over-year deflation is expected to moderate slightly, but both reports are in deep negative territory. A deflationary environment can only be exacerbated by yuan appreciation.

With the large fiscal stimulus and infrastructure projects, fixed investment is also likely to remain strong. But this is not a wholly good thing in China. Each unit of investment is generating small contributions to growth and to employment. China's investment has reached a point of diminishing returns and in some industries, exacerbates the excess capacity/production problem which further aggravates deflationary forces.

The bottom line is that the real sector data will likely show that China's recovery remains intact, but China still has little incentive to allow its currency to resume the 7/05-7/08 appreciation trend any time soon.