CNY: Underlying Currents Beneath the Calm Surface

Recently, there has been turbulence in overseas markets, while the domestic currency market remains relatively calm: both government bonds and the USDCNY are fluctuating within a narrow range. With the "G2 dual strength" scenario, RMB has appreciated slightly against non-USD currencies such as the Japanese yen.How should we view the outlook for interest rate and exchange rate markets?In my opinion, beneath the calm surface, marginal changes in the domestic fundamentals are gradually emerging.

From a timing perspective, the recent focus is on the July Politburo meeting, with the next potential node possibly in September or even in the fourth quarter.Dragged by subsectors of domestic demand such as investment and consumption, actual GDP growth in Q2 (4.3%) has fallen below the annual growth target (4.5%-5.0%), forming a stark contrast with the high nominal growth rate (5.9%) under rising PPI. If the current economic trajectory continues in Q3, the necessity for counter-cyclical policies this year is self-evident.

More importantly, some signs suggest that these economic changes may have caught the policymakers' attention:At the July 13 forum on the economic situation with experts and entrepreneurs, the Premier mentioned "increasing the intensity of counter-cyclical adjustments," marking the first time this year it was not mentioned alongside cross-cyclical policy; compared to April's forum, which featured mainly AI and tech entrepreneurs, the latest meeting had more representatives from retail and manufacturing sectors. The PBOC’s Q2 monetary policy meeting added the phrase "structural divergence" in the economy, indicating more caution than in April.

On the other hand, although export growth remains relatively high, I believe its pull on the economy is still limited, and there are downside risks in Q3.Since the second quarter, price factors have been the main driver behind over 20% high export growth, while high-frequency data on shipped volumes show only about 5% year-on-year increase, with a marked decline since July. With both imports and exports simultaneously impacted by the rise in international commodity prices, the year-on-year growth rate of the Q2 trade surplus was only 1%; exports contributed 0.9 percentage points to Q2 GDP, just 0.1 points more than Q1. Looking ahead to Q3, exports alone will not be enough.

Finally, the fastest phase of domestic price increases has already passed, removing clear constraints on monetary policy.The uptrend in June PPI (4.1%, previous: 3.9%) has clearly slowed, and transmission to industries outside the energy and chemicals chains is basically complete. Even if geopolitical tensions flare up again and oil prices experience another peak, domestic end demand remains insufficient, limiting further price increase momentum, which clears obstacles for potential monetary easing.

Considering that this year marks the conclusion of the "three-year six trillion yuan debt resolution," if one had to choose a channel for counter-cyclical policy implementation, I believe monetary measures are more likely than fiscal ones. The recent discussion in the bond market regarding the lowering of deposit rate ceilings in some regions, while not necessarily indicating a nationwide rate cut, is understandable (the last deposit rate cut was in May 2025; since 2024, long-term deposit rate cuts and OMO reductions have basically been in sync).

To summarize today’s discussion:

Marginal changes in domestic fundamentals are gradually emerging, and strong exports cannot mask the drag from weak domestic demand. The likelihood of counter-cyclical policy action this year is increasing, with September being more likely than July in terms of timing. For bonds, the long end offers better value than the short end; maintaining a position in 10-year government bonds is recommended. In the short term, the RMB exchange rate is expected to be stable; in the medium term, a shift could occur if monetary easing is implemented.

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