China local markets Report Interpretation

Overview

This weekly China local-markets update argues that weak domestic demand and slow fiscal spending should reinforce CGB curve flattening, while a softer dollar backdrop and reduced PBoC resistance create room for further CNY appreciation. The institution re-engages with CNH longs and adds a 30Y-versus-5Y CGB curve-flattener.

Core views

China is nearing the end of 3Q with only fragile cyclical stabilization. Recent PMI data indicate some improvement in production, but domestic demand remains the binding constraint and credit growth is still sluggish. Low bill-financing rates have not recovered from their decline since April despite PBoC calls for more bank lending, which the report interprets as evidence of weak underlying credit demand. This backdrop has weighed on risk appetite: Chinese equities, especially technology-heavy indices, have lagged global peers. Although the institution remains constructive on selected structural AI and technology opportunities, market leadership has rotated toward financials, commodities and healthcare, signaling a more defensive investor stance. The report argues that weak activity warrants a stronger fiscal push, but that the timing and effectiveness of implementation remain uncertain. Government and policy-bank issuance has accelerated after a slow 2Q but remains behind last year's pace; roughly 40% of the annual government-bond quota was still unsupplied as of August. More issuance could tighten liquidity before it produces meaningful growth support because the path from financing to fiscal expenditure and project execution operates with a lag. Local leadership reshuffles may further delay project starts. Slow fiscal expenditure has already caused larger-than-usual fiscal-related liquidity drains, so an acceleration in supply could amplify the usual 4Q seasonal tightening even while the growth impulse remains delayed. This combination of liquidity tightening and only gradual activity improvement supports the report's curve-flattening view. The long end of the CGB curve remains relatively steep versus macro fundamentals, measured through z-scores of long-versus-short yield spreads. J.P. Morgan therefore adds a flattener by going long 30Y CGBs and paying 5Y NDIRS, entered at 66bp, with a 50bp target and 75bp review level. The position is intended to benefit if longer-end yields decline relative to the five-year point over the coming months. Recent recapitalization measures are presented as an additional tailwind for long-duration CGB demand. Regulators announced a CNY360bn recapitalization plan for eight financial institutions, including a CNY300bn direct Ministry of Finance contribution; this follows last year's CNY500bn injection into four large state-owned banks. The new program broadens coverage to policy banks and major insurers. State-owned banks and insurers now own nearly 70% of total CGBs, up from around 65% before the earlier recapitalization. With loan demand subdued and high-quality credit assets limited, banks could place some additional balance-sheet capacity in government bonds. Insurers are a structural source of ultra-long bond demand, and their bond holdings have generally grown faster than total AUM even as equity allocations rose. The report therefore expects stronger insurer capital positions to support incremental long-duration CGB demand and a flatter curve. On FX, USD/CNH has fallen more than 1% in 3Q26 and moved closer to 6.70 amid a lower USD/JPY and a softer broad-dollar environment, returning CNH total returns to positive territory. The report believes this can encourage renewed corporate USD selling, with exporter conversion flows typically strengthening into year-end. While the PBoC still appears to manage the appreciation pace through the spot-fix gap, its fixing stance has become less defensive since August: the weakening bias versus J.P. Morgan's countercyclical-factor model has narrowed, and the fixing has broken below 6.78. CNY has nevertheless lagged regional currencies including JPY, KRW and AUD, contributing to weakness in the CFETS trade-weighted basket. With the CNY TWI below this year's highs, the report sees more room for appreciation and for the PBoC to ease FX management further, particularly ahead of President Xi's expected late-September US visit and the National Day holiday. It notes that high-level US-China presidential engagements have historically coincided with declines in USD/CNH, although expectations for major negotiation breakthroughs are modest. On this basis, J.P. Morgan re-engages with long CNH against USD and EUR at 100, targets 102 and sets a 99 review level; it also moves overweight CNY FX in GBI-EM. The year-end USD/CNY forecast is maintained at 6.70, with downside risks if USD/JPY continues lower and broad USD softness persists.

Analysis framework

The report links domestic activity, credit-demand indicators and fiscal execution to liquidity conditions and the shape of the CGB yield curve. It then assesses demand from recapitalized banks and insurers for long-duration bonds. For FX, it combines USD/CNH performance, CNH carry-adjusted returns, PBoC fixing behavior, regional FX comparisons, the CFETS basket and event history around presidential summits.

Methodology notes

• Fixed Income and CreditYield curve analysis

  CGB curve steepness and a 30Y CGB versus 5Y NDIRS flattener

  The report compares long- and short-end yield spreads with their historical distribution and positions for the long end to outperform the five-year point if the curve flattens.

• Other

  Model-based assessment of CNY fixing bias and yield-spread-based USD/CNH fair value

  The report compares actual PBoC fixings with its estimate incorporating the countercyclical factor, alongside rate-fundamental FX measures, to judge the degree of policy resistance and potential CNY appreciation.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• CNH versus USD and EUR

  The report re-engages with a long CNH position as it expects further CNY strength.

  Strengths

  Positive CNH total returns, prospective corporate USD selling, a softer broad dollar and moderating PBoC fixing resistance.

  Weaknesses

  The PBoC still appears to manage the pace of appreciation through the spot-fix gap.

  Comparison

  CNY has lagged JPY, KRW and AUD, while the CNY TWI has fallen from this year's highs.

  Risks

  The report notes only modest expectations for major US-China negotiation breakthroughs.

• 30Y CGBs versus 5Y NDIRS

  The report adds a curve-flattening trade through long 30Y CGBs and a 5Y NDIRS payer.

  Strengths

  A relatively steep long-end curve, expected 4Q liquidity pressure and incremental demand from recapitalized banks and insurers.

  Weaknesses

  Fiscal issuance may affect liquidity before it generates growth support.

  Comparison

  The back end of the CGB curve is described as steep relative to underlying macro fundamentals.

  Risks

  Fiscal execution and project deployment may remain slow, including because of local leadership reshuffles.

Key data

• Government bond quota remainingAround 40%Share of the annual government-bond quota still unsupplied as of August.
• Financial-institution recapitalization planCNY360bnPlan for eight financial institutions, including CNY300bn contributed directly by the Ministry of Finance.
• Prior large-bank capital injectionCNY500bnCapital injection into four large state-owned banks last year.
• Banks' and insurers' share of CGB holdingsNearly 70%Up from around 65% before last year's recapitalization.
• 30Y CGB versus 5Y NDIRS tradeEntry 66bp; target 50bp; review 75bpLong 30Y CGBs overlaid with a 5Y NDIRS payer.
• USD/CNH move in 3Q26More than 1% lowerUSD/CNH moved closer to 6.70, lifting CNH total returns back into positive territory.
• CNH versus USD and EUR tradeEntry 100; target 102; review 99The report re-engages with the long-CNH position.
• Year-end USD/CNY forecast6.70Unchanged, though the report sees downside risks to this forecast profile.

Impact & implications

The report expects delayed fiscal spending and seasonal liquidity pressure to favor long-end CGB outperformance relative to the five-year point. It also sees improving CNH carry-adjusted returns, potentially stronger corporate conversion flows and less defensive PBoC fixing behavior as supportive of further CNY strength.

Risks

• Fiscal implementation may be delayed or less effective than expected, limiting the intended growth support from bond issuance.
• An acceleration in government-bond supply may tighten liquidity before fiscal spending and project execution improve activity.
• The PBoC may continue to manage the pace of CNY appreciation despite its recently less defensive fixing stance.