Expect the RMB to appreciate by 3-4% versus the USD in 2012

Expect the RMB to appreciate by 3-4% versus the USD in 2012

 China growth to slow to 8.4% in 2012 from 9.2% in
2011, but H2 growth set to come roaring back
 Housing market and export slowdown are the two
biggest near-term risks
 However we don’t expect a hard-landing of the
Chinese economy because of supportive fiscal policy
and some monetary easing (RRR cuts)
 Position for CNY medium-term appreciation
through a short USD/CNY 3m NDF trade

Market view
 Going into 2012, the Chinese economy faces two
major near-term risks on growth. On the external side,
uncertainty in the Euro area sovereign debt crisis and
softening global demand continue to be a drag for
China’s export sector. On the domestic front, the
slowdown in housing market activity and the decline in
house prices, although a desirable outcome driven by the
authorities’ tightening measures, may gain speed in
coming months and may increase the downside risk on
the macro economy associated with a sharp correction.

 The key macro policy theme for 2012 continues to be
“proactive” fiscal policy and “prudent” monetary
policy. On fiscal policy, we expect tax cuts and increases
in government expenditures to support certain sectors,
such as affordable housing, services, medicare, the social
safety net, water conservation, and subway investment.
On monetary policy, we expect four more RRR cuts this
year, including three cuts in 1H. On the credit side, we
look for new loan creation of 8.2 trillion yuan in 2012, up
from 7.47 trillion last year.

 Housing market correction poses major domestic
risk. The rapid increase in China’s house prices since
2009 has been unprecedented both in terms of scale and
scope. This year, we expect a house price correction in
China of 5-10% at the national level, with price declines
of 15- 20% in some tier-1 cities. But, the likelihood of a
collapse scenario remains small.

 Banking system exhibits rising risks, but there is no
imminent crisis. Concerns about Chinese banks were
high throughout 2011, as reflected in the poor
performance of the stock market, despite their high
profits and solid regulatory buffers. We expect that
nonperforming loan ratios will increase significantly in
the next 2-3 years. However, this rise in NPLs is unlikely
to lead to a banking crisis.

 RMB will gradually appreciate in the medium term in
spite of external risks. Late in 2011 and early this year,
the RMB exchange rate hit the lower limit of its daily
trading range, with the offshore market pricing in RMB
depreciation. However, RMB depreciation is unlikely to
persist. We believe the RMB will maintain its gradual
appreciation path in the medium term.

 We expect the RMB to appreciate by 3-4% versus the
USD in 2012. First, our macro view is that a hard landing
in China is unlikely. Second, China will continue to
register current account surpluses, although their
magnitude will decline (from an average of 7.8% of GDP
in 2005-09 to 2-3% in the next two years). A gradual
appreciation path will help China rebalance away from
exports and into domestic demand, as well as moderate
external accounts and slow FX reserve accumulation. In
the near term, we think the Chinese authorities could
enlarge the daily trading band to encourage increasing
flexibility of FX movements, in preparation for their
longer-term strategic objective of achieving full currency
convertibility.

FX strategy
 One of our top FX trades in Asia is to favor a short
3m USD/CNY FX forward, and to keep rolling this
over throughout the year. After a significant drop in
USD/CNY spot in late December, PBOC has kept spot
nearly unchanged year-to-date amid EUR weakness. We
expect authorities’ desire for appreciation will show itself
over time. We also like to be long a 1y USD/CNH FX
option call as a hedge against flare-ups in China hardlanding
concerns. We believe that USDCNH forwards
will rise sharply on any sign of stress in the funding
markets, just as happened in 3Q

JP Morgan Forecasts CNY