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China: a turbulent start in 2016

It seems to be a very uneasy start of 2016, for Asian markets, especially China. Two out of first four trading days, the new rule of circuit breaker has been triggered twice where CSI300 index experienced 7% down twice. Along with it, since Dec 28th within the 7 trading days, CNH, CNY, and CNY mid-point depreciated by 1.97%, 1.62%, and 1.38%.

We believe the mechanism of circuit breaker will be improved and it won’t be a new normal for Ashare investors. And we think RMB is the key trigger for the domestic market corrections this week, where PBOC plays the leading role in this currency move. We think it is an appropriate macro policy at this juncture of wide spread global currency depreciation after the Fed funds rate hike since Dec 16th 2015.   

What is circuit breaker?

China’s Securities Regulatory Commission (CSRC) implemented this rule from the first trading day of 2016. The key characteristics:

  • Circuit breaker is only on the benchmark index CSI-300
  • CSI300 index ±5% movements lead to a 15-minute break, while ±7% index movements lead to a trading halt for the rest of the day
  • When circuit breakers triggered, it affects: A shares, B shares, funds (excluding gold ETFs, exchange-traded money market funds, and bond ETFs), convertible corporate bonds, and exchangeable corporate bonds; all stock index futures products including CSI-300, CSI-500 and SSE-500 index futures, but treasury bond futures are not affected.

Will circuit breaker become a new normal for Ashare investors?

  • On Jan 4th, the first trading day, CSI300 index touched 5% down at 13:13, with 15mins trading suspension, it took 6 mins to have another 2% down, by triggering circuit breaker again, and a trading halt for the rest of the day
  • On Jan 7th, the fourth trading day, CSI 300 index touched 5% down at 9:42am, with 15mins trading suspension, it took only 2mins to have another 2% down, by triggering circuit breaker again, and a trading halt for the rest of the day
Graph-1
  • It is exaggerating the market fear, but clearly not the cause of the market fear. We don't think circuit breaker will become a new normal for Ashare investors. However the mechanism needs to be improved.

What are defects in circuit breaker?

CSRC said it will improve the circuit breaker rule. Circuit breakers have been adopted by a number of countries, including the US, South Korea and Japan, and overall have performed well as a market stabilizer. The two big differences are:

  • Threshold: The 5% and 7% thresholds are too close to each other and added to investors’ fears. As a comparison, the US has set three thresholds of 7%, 13% and 20%, and Korea has set three thresholds of 8%, 15% and 20%.
  • T+0/T+1 trading rule: Under the T+0 trading rule, investors can do intra-day trading to mitigate losses from their previous investment decisions. Under the T+1 trading rule adopted by China, potential stock buyers may hesitate as they won’t be able to change their decision, i.e. to sell, if the stock prices fall further.

What is the key trigger of market correction?

RMB! Among all reasons - sluggish PMI, 1.1trn RMB unlocking pressure, domestic institutional investor repositioning, we think RMB is the key trigger of the market correction. Market gets more and more nervous with accelerated CNY depreciation recently. When we review the movement closely, there are some patterns market should not lose sight of:

  • PBOC has fixed CNY mid-point with consecutive depreciation pattern ever since Dec 28th 2015, for 8 trading days in a row.
  • CNY and CNH followed the CNY mid-point movement. Hence PBOC leads the whole game here.
  • In term of the 7 working day move, CNH depreciation overshoot slightly by 1.97%, vs. CNY 1.62%, and CNY mid-point by 1.38%
  • As far as we understand, PBOC is using this 2015 year end, and 2016 year start window, to depreciate the currency to a desirable level, by saving its FX reserves. We think it is an appropriate macro policy at this juncture, when we reflect several months later.
Graph-2
  • After Fed rate hike, global currency move is as shown in the below chart. The move of CNY is appropriate given the comparison with other currencies globally. It is a good window for PBOC to act now than later. 
Graph-3

Source: Bloomberg, Amundi Research

What is China macro and market outlook then?

  • Economy: we continue to hold the view, Chinese economy is bottoming in a narrow range, and would rather be a stabilizer for global economy in 2016/2017
  • Policy: aggressive monetary (though they don’t call as QE), fiscal (though they don't call as stimulus), property, and investment policies will continue and extend in 2016 and beyond to counter the economic downturn
  • Liquidity: ample liquidity is the market given aggressive easing, given partially capital control happening capital outflow pressure remaining high but not easy any more
  • Market: overall, we think PBOC is a late comer in aggressive monetary easing following the Fed, BOJ and ECB in order, hence this ample liquidity will support the market in general. However selling pressure is high for the market, even though CSRC just released they cap large holder stake cut at 1% of total within 3 months. Hence, the market volatility is there along the year.

Conclusion

We believe and we hope China would rather be a stabilizer for global capital markets, and a growth driver for global economy, are not only wishful thinking. 

 

 

 

 

 

   

Mo JI, Amundi Hong Kong Chief Economist
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China: a turbulent start in 2016
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