China Rates Strategy:Wait for more economic data

January inflation and credit data went higherThe YoY growth rate of CPI was 2.5% in January 2017, a bit higher than the market'sexpectation, and the PPI YoY growth rate rose to 6.9%, significantly higher than themarket's expectation. UBS's China Economist raised the 2017 PPI forecast from 2.5%to 4.3% recently, while keeping the 2.3% forecast for CPI. In addition to inflation,January's total social financing also beat the market's expectation, reaching Rmb3.7trn,higher than Rmb3.5trn in January 2016. The proportion of enterprise medium- to longtermloans among total loans also went up further.

    The policy tone remained the same in PBoC's Q416 monetary policy reportWe think the Q416 Monetary Policy Report (the Report) newly released by the People'sBank of China (PBoC) indicated that the tightening monetary policy tone is likely toremain the same in the next couple of months, but the central bank would stillintervene when large market fluctuations appear. Considering the PBoC's attitudetoward inflation, we don't think it appears likely to raise the benchmark interest ratedue to pressure from inflation; but in order to achieve its policy target, further rises inmedium lending facility (MLF) and open market operation (OMO) rates cannot beexcluded. Besides, as the Report put controlling risk in a more important position, wethink there's still risk from tighter financial regulations in the future, although thecentral bank may avoid conducting them too aggressively.

    Wait for more economic data to be released in MarchWe think the central government bond (CGB) yield curve may fluctuate in a small rangein the short run. From one perspective, the market's expectation of long-term liquidityconditions has not improved much. We think even if liquidity pressure is released in theshort term, with repo rates going down, room for the front-end of the yield curve to golower may be limited. From another perspective, we think there's still uncertainty inwhat the economic data will be like in the next couple of months and the long end ofthe yield curve may not go much lower either. Considering the tenor spread, we thinkthe 10-year CGB yield may not go below 3.2%.

    The market is set to see another data-releasing period in March. We think comparedwith inflation, the credit and January-to-February property and fixed-asset investmentdata are more important to watch, related to how the monetary policy tone wouldchange. In addition, the National People's Congress (NPC) and Chinese People'sPolitical Consultative Conference (CPPCC) meeting to be held in early March may alsoprovide information regarding this year's economic and monetary growth targets. Wethink whether optimistic market sentiment can continue depends on support fromeconomic data. If it comes out stronger than expected, the 10-year CGB yield may goback to around 3.5%; however, if the data shows weakening signals, it may bring afurther downward adjustment opportunity for the yield curve. We think investorsshould wait for more economic data to get a clearer view on direction.