Q2 2022 Emerging Global Market Themes: Rising US Treasury Yields and Weakening JPY (Part 2)

Jhis article is written by CMC APAC market analysts; Kelvin Wong, Tina Teng and Leon Li

Sector View on U.S. Equities

According to the stories above, central bank policies tend to be more focused on fixing soaring consumer prices, rather than stimulating growth, in turn dragging the US economy into an era of “stagflation”, which may continue to encourage investment funds to withdraw. growth stocks and look towards defensive sectors, such as utilities, healthcare and consumer goods. Also, we expect the energy sector will continue to lead Q2 performance due to war-intensified supply shortages and soaring inflation.

Growth stocks, typically in the consumer discretionary, communication services and technology sectors, are expected to underperform the S&P 500, amid slowing growth and downgrades in valuations, in which we can see individual stock performance variables dependent on cash flow conditions and sentiment dynamics. .

Besides, banking stocks could suffer from a possible credit crunch due to the rising cost of borrowing, as well as the extension of sanctions against Russia.

Performance of S&P 500 sectors

Source: TradingView (click to enlarge table)

Chinese yuan trend from 2020 to 2022

Looking at the trend of the yuan over the past two years, USD/CNH has entered a substantial depreciation trend since May 2020.

Source: CMC Markets (click here to enlarge the table)

The yuan’s two-year outperformance against the US dollar is also evident across the board. The CFETS RMB index which measures the value of the yuan against a basket of 24 major currencies has jumped more than 16% since June 2020, compared to a 12% gain seen only against the US dollar.

Source: CFETS (click here to enlarge the table)

Since last November, the US Federal Reserve has embarked on a cycle of tightening debt, raising interest rates and shrinking the balance sheet. In contrast, China’s monetary policy shifted to a targeted expansionary mode where China’s central bank, the PBOC, cut the reserve requirement ratio of commercial banks and benchmark lending rates. However, despite a more hawkish monetary policy stance designed by the Fed compared to a dovish mandate from the PBOC, it failed to halt the yuan’s appreciation against the US dollar.

The logic behind the strength of the yuan: The PBOC tightened its monetary policy regime after May 2020 while the Fed maintained its quantitative easing program. The long-term strength of a currency depends on the fundamentals of a country. China is the first country to recover from the COVID-19 pandemic crisis and its GDP growth rate in 2021 exceeded the rest of the world in general, which in turn attracted a large amount of inflows of international capital which led to a persistent trend appreciation of the yuan.

However, the current strength of the yuan should be limited to the second quarter of 2022., mainly because the Fed will implement a faster interest rate hike cycle and a higher quantitative tightening regime to reduce its $9 trillion of bonds on its balance sheet. In addition, China’s manufacturing sector suffered a sharp contraction in March, so such weak economic data could prompt the PBOC to move forward and accelerate its pace of monetary policy easing.

Against the backdrop of China’s economic slowdown, the conclusion of the PBOC’s fourth quarter 2021 meeting said its primary monetary policy objective is to maintain economic stability. Judging by this statement, the main focus of subsequent monetary policy decisions will shift to achieving stable growth and, therefore, in the future, the monetary policy environment may become more accommodating, which which will likely trigger downward pressure on the yuan.

Chinese policymakers have always implemented a balanced control of the yuan. Specifically, they don’t want it to rise or fall significantly and China’s manufacturing industry has seen a significant slowdown in growth due to the strong appreciation of the yuan, the recent outbreak of Covid-19 infections in major trading centers such as Shenzhen and rising raw material costs. Thus, it is necessary for China to achieve a stable exchange rate since the manufacturing sector contributes significantly to its overall economic growth.

Does this mean a major bearish move is on the cards to reverse the yuan’s recent strength? Since the last round of global liquidity easing in 2020, a strong yuan has become a favorite for foreign capital and after the Fed kicked off its current round of interest rate hikes, there could be increased pressure for foreign capital to convert their yuan-based financial capital. US dollar holdings. At the same time, if the PBOC allows the yuan to depreciate sharply, it could encourage foreign capital to grab China’s key assets, which could be detrimental from a national security perspective. As a result, China will not allow its currency to depreciate significantly as it aims to achieve stable GDP growth of 5.5% in 2022, so the decline should be limited.

How will the real estate sector be affected?

Since last year, China has started to implement real estate market deleveraging policies by introducing the concept of “housing is used for living and not for speculation” which in turn has caused a major credit crunch. for many property developers, increasing the risk of bankruptcies and debt defaults. To ease the credit crunch, the PBOC has started easing its monetary policy since late last year and injecting liquidity into the property market.

Source: Tradingview (click to enlarge table)

Since mid-March 2022, China’s real estate sector has seen a sharp upward rebound, mainly due to less stringent deleveraging policies. Policymakers have adopted a series of support measures for the real estate sector such as mergers and acquisitions, credit easing, support programs for reasonable financing demand to boost market confidence.

More than 60 cities have eased restrictions on home purchases, lowered down payment ratios, provided home purchase subsidies, lowered mortgage interest rates and provided financial support to real estate companies. A tax on multiple properties has also been delayed. In this case, the shares of many real estate companies rebounded more than 50%. However, it should be noted that this recent rebound does not mean renewed strength in the long-term fundamentals of the real estate sector. At present, most of the accommodative real estate policies are conducted in China’s second- and third-tier cities, and there is no obvious change in the policies that governed the real estate market of first-tier cities.

China’s primary focus on the real estate sector is to achieve a “soft landing” and does not want a return to an unstable high growth environment driven by excessive leverage. However, since real estate accounts for a very large portion of China’s GDP, achieving China’s 5.5% GDP target for 2022 largely depends on the real estate sector, so it needs a monetary environment. flexible to support it. In summary, the current pace of strong rebound in real estate company stock prices is likely struggling to sustain and some retracement in its stock prices is expected in the near term. However, in the context of easing monetary policy, stock prices will be broadly stable in the medium term.

How will Chinese tech stocks perform after oversold conditions?

Chinese tech companies such as Tencent, Alibaba and Meituan have continued to experience significant declines in their respective stock prices this year, mainly due to the Russian-Ukrainian war, foreign regulatory crackdown and the recent COVID outbreak. -19 in China.

In the current environment, the Chinese government has started to use policies to support these tech companies, including allowing them to register overseas. On March 16, the Financial Commission of the State Council held a special meeting which stressed that it would actively implement market-friendly policies and cautiously introduce restrictive policies, which meant that the last year of Strict regulatory crackdowns on the business practices of tech platform companies may end soon.

In addition, several listed companies have implemented large-scale share buyback programs such as Alibaba.

Chinese and US regulators have recently held several rounds of talks in a bid to resolve some lingering issues in cross-border regulations, which in turn reduce the chances of Chinese ADRs being delisted from US exchanges. Overall, these latest developments have managed to quell the negative sentiment, which will likely help slow the pace of the major downtrend in Chinese tech stocks.

Click here to read Part 1 of Emerging Global Market Themes Q2 2022

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