With the coronavirus outbreak still evolving, the market signal is clear: less growth and more accommodative policy in China.
Further to our forecast given in the previous issue of China Insight that "China will only achieve 4.8-5.3% GDP growth in 2020" because of the disaster, we in the current issue present our view on how the yield curves in China are being impacted.
The broadening of the coronavirus outbreak in China, the lockdown of Hubei province and the extension of LNY holiday have already given a hard hit to the manufacturing sector. Due to that, we inevitably will see a fall in PMI indices in Feb and March. At worst, PMI will continue to be under downward pressure over the rest of H1. In our view, some downturn of the manufacturing sector as a result of the disaster is already priced in 5yr IRS, but a drop by 2 to 3 points in PMI from here should still be able to drive IRS much lower to sub-2016 lows. Given the strong correlation between the NBS Manufacturing PMI and 5yr CNY IRS in the past (chart 1), 5yr IRS at 2.55-2.60% appears to have priced a fall in Feb PMI to around 49.0 from January's 50.0. A further decline in PMI to the 48.0 region in March or during the March-April period, in our view, will bring 5yr IRS down further to 2.35-2.45%.
As far as CGBs are concerned, chart 2 shows the 10-yr part of the yield curve has reacted more to major events, but not the RRR cut coming into effect on 6 Jan, since the beginning of the year. In our view, 10-yr CGBs will continue outperforming the shorter maturities in most of the upcoming events that intensify the speculation over more monetary easing.
It is worth noting that 10-yr CGB saw a tightening of its yield spread over the 7-day reverse repo to as little as 42bp after PBOC injected CNY1200bn of liquidity into the banking system at lower OMO reverse repo rates on 3 Feb (chart 3). Because the ongoing coronavirus outbreak is far more recessionary to the economy than the sharp devaluation of RMB in Aug 2015 was, we expect the said yield spread eventually will go below the floor established at 39bp in 2016. We won't be surprised if it finally reaches 25-30bp.
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