China Macro:May data preview,Slowdown continues

China’s economy started accelerating from 1Q16 and peaked in 1Q17. It hasdecelerated since then and the trend continued into May. That said, theslowdown is a modest one and GDP growth in 2Q17 is on track for 6.7% yoy.

    As such, the next couple of months will remain a window for policy makers todeleverage the financial system. The focus of policy makers will shift tosupporting growth sometime in 3Q17, when the slowdown threatens the 6.5%bottom line growth rate.

    Slowdown continues into May: We expect industrial production to slow to6.3% yoy in May from 6.5% in April. That said, end-user demand held-up well.

    Cement prices kept rising in May (chart at left), despite dropping during thesame period in 2014 and 2015. Headline FAI growth in Jan-May could rise to9.0% from 8.9% due to the very low base last May, which is partly the result ofthe anti-corruption campaign in Liaoning Province. That said, underlyingmomentum for investment is on a downtrend. Up until April, ‘PlannedInvestment in New Projects’ saw negative growth for four months. After all, itmakes no sense for policy makers to waste ammo when the economy runs atthe pace seen in 1Q17.

    Trade, inflation capital flows and credit: Trade is the bright spot in 2017.

    We expect trade growth in May to be around 10% yoy, similar to April. Assuch, the trade surplus will rise to around US$50bn. Meanwhile, disinflationcontinues as the PPI could drop to 5.8% yoy in May from 6.4% in April. Thatsaid, CPI is likely to edge up to 1.4% yoy from 1.2% on a low base. Thanks tothe weak US dollar, China’s FX reserves in May should rise for a fourth monthin a row. Finally, we expect 10.4% M2 growth and Rmb800bn new loans inMay, which is still accommodative. In the past six months, policy makers havebeen cautious in maintaining a steady pace of liquidity growth in the realeconomy while tightening liquidity in the financial system.

    Three risks in the economy: The first is ongoing financial tightening.

    Liquidity could become tighter in June on the PBoC’s Macro PrudentialAssessment (MPA) at quarter-end. The second one is the property sector. InJan-April, national property sales rose 16% yoy, a very strong reading.

    Compared with the past seven years, it’s only lower than 2013 and 2016.

    However, sales in the top-40 cities (35% of the national market) only rose 2%yoy, while the rest of the country was up 25%. This raises two concerns. First,how long could the strong sales in lower-tier cities be sustained? Second, ittakes much longer for those lower-tier cities to have another property up-cyclecompared to tier1/2 cities. It means that the growth in the next couple of yearswill face strong headwinds.

    The third risk is on the external side. So far this year, China as well as otherEM countries enjoyed a benign external environment. Now in the FX market,the yuan’s implied volatility fell to the lowest level since the fixing reform inAug 2015. However, stability could be destabilizing. So far this year, policymakers have adopted a strategy which deviates sharply from the past. Insteadof allowing the yuan to fluctuate more, they have kept the USD/CNY in anextremely narrow range around 1/6.9 (bottom left). This strengthened thebelief held by many investors and domestic corporates the yuan is pegged tothe dollar when the dollar is weak, and it will depreciate against the dollaronce the dollar is strong. With such an expectation, if the dollar strengthens in2H17, depreciation and capital outflow pressures will strike back.