China – summary slides

The deflation problem

The weakness of markets is partly a reaction to the Congress, but particularly in the case of $CNY, also a natural consequence of China's economic slowdown. The construction and consumption recessions mean that while the rest of the world is in inflation, China is dropping into deflation. The PBC is reacting by loosening policy, creating a widening nominal rate differential with the US. On this basis alone, $CNY will likely get to 7.5 or more.

The short-term outlook

There are signs that the industrial cycle has reached a floor. That follows the accelerated easing in the last few weeks. Beijing hasn't folded, but it has blinked, meaning the record sharp fall in mortgage rates in Q2 has been repeated since. Downside risks still exist because the cycle is so bad, developers are still in trouble, and CNY weakness risks triggering further capital outflows. But whereas the risks around growth through the summer have all been to the downside, now they are more balanced.

The Congress contradiction

The congress doesn't change the short-term picture. But it does affect the longer-term outlook. Quite how is unclear, given the unprecedented nature of the changes of the last few days, but we do at least know two of the questions to ask. First, does the economic management style pursued by outgoing policymakers – particularly reducing leverage and improving the business environment – now change? Second, and ultimately more importantly, just how will Xi Jinping square the current apparent disregard for growth with the oft-repeated aim of China becoming a strong, rich nation by 2035?