Chinia Speculation

Speculation that China will tighten monetary policy this weekend is likely to prove for nought. The focus may already be shifting to next week, ahead of the Lunar New Year celebration. We have suggested that medium term traders need not get so caught up in the guess work of what the PBOC will move and focus instead on the fact that more tightening is likely forthcoming and front-loaded at that.

Financial institutions already appear to be preparing of the extended holiday. The 7-day repo rate, which is a measure of the availability of the interbank liquidity jumped almost 500 bp this week. It reached nearly 8.% before easing back off before the close of the local market today.

The Shanghai Composite fell to new lows since last October today and is off about 16% since the mid-November high. News that the country's largest mutual funds company boost its real estate holdings boosted the property developers, which staged their biggest rally in two weeks and some other banks/asset managers opined that the sector was attractive. FXI appears to be among the most liquid ETFs this space.

China has responded to higher food prices, which is a major driver of their measured price pressures but tapping into the country's strategic reserves of foodstuffs, especially grains and cooking oil.

The other major issue for Chinese officials is the growth in new loans. New yuan loans rose by CNY481 bln in December, a third more than the market expected even if lower than Nov. However, the reports from local contacts suggest new loans in January have surged to more than CNY1 trillion.

The 12-month non-deliverable forward implies expectations for a 1.7% appreciation of the yuan. We suspect this is under-estimating the likely appreciation, which we would put closer to 5%.