2021 was the year when Beijing decided to shift its policy focus from economic recovery to structural reforms. 2022 is a politically significant year. It will likely be marked by passivity in financial and regulatory policies and a focus on general stability. We believe this should be positive for RMB bonds (lower yields), neutral to positive for equities, and positive for the Chinese RMB.

China reclaimed their 2019 level of economic output a mere six months after the Covid-19 Pandemic started. Moreover, this remarkable expansion of 2.3 percent in 2020 came when the rest of the world struggled to reclaim lost output. At the start of 2021, China's economy was significantly ahead of the US and Europe in its recovery from the Pandemic shock. China’s relative and absolute economic strength was so ample in early-2021 that Beijing deemed it appropriate to promulgate acute regulatory reforms (Common Prosperity) and general deleveraging, including within the property sector. The idea was that to set up the policy platform for President Xi’s third term (2022-2027), China needed to extricate itself from the trade-driven growth-obsessed economic model and to shift its collective focus to ridding itself of systemic risks so as to permit the next phase of protracted economic expansion with minimal social and other systemic risks.

This is akin to a car manufacturer shifting their focus from building the fastest car to making a car with superior handling, reliability, and safety.

It was not straightforward for Beijing to precisely calibrate the regulatory reforms last summer and the impact on the economy and general sentiment. At the Central Economic Work Conference in December 2021, Beijing announced that their policy focus for 2022 would shift from reforms to stability, effectively admitting that they might have overdone it with the reforms. It was time to consider supporting the economy as it worked through the reforms.

We believe the bearish interpretation of China’s policies (authoritarian and blunt) and the state of its economy (brittle and fragile) is likely to be incorrect. Economic growth will likely decelerate toward 5 percent in 2022, from 8.1 percent in 2021, with tame consumer inflation. But, in our opinion, this would be intentional and necessary for desirable structural reorientations, not something sinister. Financial policies will likely be passive, targeted, and restrained. Despite the US Treasury yields rise, China’s 10Y CGB yield could drift toward 2.50 percent later this year.

The RMB has been supported by a significantly favourable balance of payments position, flattered by strong global demand for goods and weak domestic demand for imports and foreign travel. As a result, the RMB will likely experience sustained appreciating pressure and may trade through 6.0 against the USD this year. EURUSD, at the same time, may meander within the 1.10-1.17 zone.

Together, the above outlook bodes well for our RMB bond fund. We aim to maintain our long duration exposure and our long CNY posture. This is our central case view, but we explore below some of the risks to this scenario.

The full report contains the following topics:

• The Chinese economy will remain divergent from much of the rest of the world
• Long yields will continue to trend lower
• The property sector and corporate defaults will pose challenges for China
• Policy Banks look a bit rich
• How much longer will the RMB remain strong?
• Risks to our outlook