JPMorgan: Economic Weakness Benefits Long Bonds, RMB Under Pressure Short-Term but Bullish Mid-Term

Overview

This weekly report focuses on two main themes in the China local market: first, the logic supporting interest rate bonds amid slowing domestic growth momentum; second, the unique performance of the RMB against a backdrop of weakening USD and the PBOC's policy intentions. The report argues that weak macroeconomic data and accommodative signals from the Politburo meeting have jointly driven strength in long bonds and curve flattening. In FX, despite the decline in the dollar, the RMB has lagged in the short term due to crowded positioning and PBOC pace management, but the foundation for mid-term appreciation remains solid.

Core views

Macro Growth and Interest Rate Trends: Both official and Caixin PMIs for July point to a weak start in Q3, with manufacturing and services momentum slowing simultaneously. The output index falling below the 50 threshold raises concerns about the sustainability of June's industrial rebound. Domestic demand下滑 is particularly evident, with the construction PMI dropping to 47 in contraction territory, reflecting sluggish real estate and disruptions from extreme weather. Against this backdrop, coupled with the Politburo meeting reiterating 'counter-cyclical adjustment' and hinting at incremental policy support, expectations for further PBOC easing have risen, prompting investors to extend duration. Yields on 30-year and 50-year government bonds fell by 8-14 basis points over the past month, driving curve flattening. The report notes that while the curve has flattened somewhat, the 10+ year segment remains relatively steep. If growth continues to stagnate without large-scale fiscal stimulus, there is room for further flattening. Although the 10-year government bond yield is below the model-calculated fair value of 1.84%, the deviation is not extreme enough to trigger a reversal, and long bonds still hold allocation value in the current macro environment. RMB Exchange Rate and PBOC Policy: The US dollar index has recently fallen sharply by 1.8%, yet USD/CNH has only gently declined and stalled after breaking below 6.75, performing significantly weaker than the Euro and Yen. The report attributes this to differences in position structure: emerging market client surveys show RMB long positions are at multi-year highs, lacking the动力 for short covering to amplify appreciation as seen in summer 2024. Meanwhile, PBOC reference rate signals have recently turned resistant to further declines in USD/CNH, indicating control over the appreciation pace. However, the report emphasizes this is more of a 'tactical pause' than a fundamental policy shift, as the RMB's real effective exchange rate is far from reaching extremes seen in previous cycles, and July export data exceeded expectations with strong high-tech product exports. This indicates that China's export competitiveness' sensitivity to exchange rate fluctuations has decreased with industrial chain upgrades. Trade surpluses and corporate settlement demand continue to provide structural support for the RMB. As prior option trades expire and close out, the report maintains its mid-term bullish view on the RMB, planning to re-establish long positions against the USD and EUR once market positions clear.

Analysis framework

The report adopts a transmission analysis framework of 'Macro Fundamentals → Policy Signals → Market Pricing and Positioning'. For rates, it verifies growth quality by comparing official and third-party PMI data, judges policy direction by analyzing wording changes in the Politburo meeting statement, and assesses bond valuation and trading space using yield curve shape and historical percentiles. For FX, it not only focuses on external drivers like the US dollar index but also introduces 'positioning' as a key explanatory variable. By comparing current holdings with historical ones (e.g., summer 2024), it explains the lack of exchange rate elasticity. It also combines PBOC reference rate deviation signals with structural changes in export competitiveness to distinguish between short-term tactical intervention and medium-to-long-term equilibrium trends, avoiding misreading the PBOC's pace management as a directional reversal.

Methodology notes

• Macroeconomic framework

  Tracking PBOC Reference Rate Signals and Identifying Exchange Rate Pace Management

  By analyzing daily deviations of the RMB reference rate relative to market models and their rolling changes, it determines whether the PBOC is guiding appreciation/depreciation or 'applying the brake' to control volatility speed. In this report, this indicator is used to distinguish between the PBOC's tactical stabilization and strategic policy shifts.

• Event Game and Behavioral FinanceFund Flow/Chip Analysis

  Non-linear Impact of FX Market Positioning on Price Elasticity

  When long or short positions for a currency are extremely crowded, prices struggle to make significant further moves even if fundamentals are favorable, due to a lack of new buying or selling pressure. The report uses this to explain why the RMB reacted sluggishly despite the sharp drop in the USD, distinguishing it from the appreciation amplification effect brought by short covering in summer 2024.

• Fixed Income and Credit AnalysisYield curve analysis

  Yield Curve Shape and Duration Strategy Selection

  Judging the steepness or flatness of the curve by observing historical percentiles (Z-score) of the spread between short and long ends. The report found the 10+ year curve is still steep. Combined with downward revisions in growth expectations, it derives the trading logic of 'extending duration + betting on curve flattening'.

• Industry/Industrial Analysis FrameworkValue chain analysis

  Upgrading Global Value Chain Position Reduces Exchange Rate Elasticity for Exports

  As a country's manufacturing climbs to higher-end segments and enhances pricing power, its export share becomes less sensitive to nominal exchange rate changes. The report uses this to argue why RMB appreciation has not significantly harmed exports, thereby removing a key constraint on the PBOC's tolerance for appreciation.

Key data

• Official Manufacturing/Services PMIBelow expectations, Output Index <50July data unexpectedly declined, raising doubts about the sustainability of June's industrial rebound
• Construction PMI47Deep in contraction territory, reflecting sluggish real estate and disruptions from heatwaves and heavy rain
• 30-Year/50-Year Government Bond Yield ChangeFell 8-14bpLong-end led gains over the past month, driving curve flattening
• 10-Year Government Bond Model Fair ValueApprox. 1.84%Current actual yield is below this value, but the deviation is not at extreme levels
• US Dollar Index (DXY) Drop Over Past Two Weeks1.8%USD weakened significantly, but USD/CNH reaction was muted
• RMB Long PositionsMulti-year HighsEM client surveys show crowded bullish sentiment, limiting short-term appreciation momentum

Impact & implications

For the bond market, the report believes that under a baseline scenario of weak growth and lack of strong stimulus, there is still room for long-end rates to fall, and the trend of curve flattening may continue until the 10s30s spread returns to multi-year averages. It suggests maintaining long-duration exposure. For the FX market, short-term vigilance is needed regarding PBOC pace management and震荡 caused by digesting long positions, but the mid-term RMB appreciation logic remains unchanged. Structural improvements in export competitiveness mean the policy layer's tolerance for RMB appreciation has increased, and future guidance for appreciation may resume during diplomatic windows (such as visits to the US).

Risks

• Implementation of large-scale fiscal or demand-side stimulus could interrupt the downward trend in rates
• RMB long positions are too crowded, making them susceptible to short-term sentiment-driven pullbacks
• The PBOC's attitude towards RMB appreciation shifts from 'controlling pace' to 'setting a cap'
• Escalation of geopolitical tensions or trade friction impacts export resilience and settlement willingness

What to watch

• Whether subsequent PMI and high-frequency data confirm stabilization in Q3 growth
• Whether PBOC reference rate signals continue to release intentions to resist appreciation
• Progress of RMB market position clearing and changes in short/long ratios
• Changes in exchange rate policy rhetoric before and after high-level diplomatic activities (e.g., US visit)
• Degree of compression in the 10s30s government bond spread and activity level in long bond trading