China Local Markets Weekly_ Looking beyond recent liquidity tightness; NPC preview. Fri Feb 28 2025

Summary of Key Points from the Conference Call Industry Overview - The report focuses on the China Local Markets and the implications of recent US-China trade tensions on the Chinese economy and financial markets [2][5]. Core Insights and Arguments 1. Tariff Risks and Geopolitical Tensions: - USD/CNH is currently tracking approximately 0.8% above relative rate fundamentals, indicating a tariff risk premium in the price, which may be insufficient against potential escalations in trade tensions [4][6]. - President Trump has threatened a new round of 10% tariff hikes on China, with a deadline approaching on April 2nd for various tariffs [6][4]. - The America First Investment Policy has introduced investment restrictions that could limit US investments in China, potentially leading to greater outflows if divestment occurs at scale [6][4]. 2. US Investment in China: - US investment in China is estimated at approximately $306 billion**, which could rise to nearly **$700 billion when including indirect exposure through offshore financial centers [6][4]. - A partial unwind of US investments could exacerbate outflow pressures for CNY FX, contributing to a bearish outlook for the currency [6][4]. 3. Liquidity Conditions in China: - The excess reserve ratio in the interbank market has decreased from 1.1% in December to 1.0% in January, indicating tightening liquidity conditions [4][11]. - The report suggests that the worst period of liquidity drawdowns may be behind, with expectations of easing from the PBoC in the medium term [4][11]. 4. National People's Congress (NPC) Expectations: - The NPC is set to begin on March 5, with expectations for a growth target of around 5% and a fiscal deficit target of 3.8% [28][30]. - Financial markets are optimistic ahead of the NPC, driven by a rebound in offshore listed Chinese stocks, particularly in the AI and tech sectors [28][30]. 5. Market Reactions and Predictions: - Historically, Chinese equities tend to rally post-NPC, with a 60-90% probability of positive returns in the month following the meeting [35][41]. - The report anticipates that if policymakers deliver positive surprises, there could be a catch-up for lagging sectors, particularly in consumption and housing [28][30]. Other Important Insights 1. Banking Sector Challenges: - Large banks in China have experienced significant contraction in corporate deposits due to regulatory crackdowns on manual interest compensation, leading to rising loan-to-deposit ratios [20][24]. - The PBoC's liquidity supply is increasingly critical for maintaining stability in the financing market amid these pressures [24][20]. 2. Potential Catalysts for Easing: - Several factors could signal a shift towards easing liquidity conditions, including moderating NCD financing pressures and potential recapitalization of large banks by the PBoC [24][25]. - The report highlights the importance of monitoring these catalysts for a potential relief rally in the market [24][25]. 3. Investment Strategy Recommendations: - The report suggests maintaining a neutral stance on duration while being cautious about adding receivers immediately due to elevated repo rates [25][24]. - There is a focus on the potential for a relief rally in front-end rates as they approach value zones following recent cheapening [25][24]. This summary encapsulates the critical insights and implications for the China Local Markets as discussed in the conference call, highlighting the interplay between US-China relations, liquidity conditions, and market expectations surrounding the NPC.