China is exporting deflation globally, short CFETS - RBS

James Nelligan, Research Analyst at RBS, notes that the market based inflation expectations in Europe and Japan have decoupled with the oil price and now trade with CNY.

Key Quotes

“As China steadily devalues the renminbi on a global trade weighted basis, via CFETS, then major trading partners import disinflation. We favour short Yuan vs. the CFETS basket. China’s money supply data is key to watch at the end of this week, where we expect M2 to continue its decline. In an alternative bullish China scenario, where data improve as credit growth works through the system, then PBoC have more leeway in currency management.

We’ve seen their preference to depreciate via CFETS. This helps tackle overvaluation fears by pulling the real effective exchange rate down. In a bearish China scenario, where ‘L’ shaped growth is delivered as promised by leading officials (source: People’s Daily) and money supply growth softens, then we expect capital outflow pressure to resume.

Furthermore, if we assume a larger NPL number, the resumption of capital outflow and potential state owned enterprise losses, then we weigh that against FX reserves, a larger fiscal deficit and sovereign wealth fund assets, it’s not clear that China has much ammunition to fight potential banking system losses. With that in mind, tackling overvaluation fears may simply be prudent policy for PBoC to carry out.”