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Key Points:
- The better-than-expected Jan-Feb macro data released today continues to reveal a “dual-speed” recovery of the Chinese economy, with better performing exports related sectors and high-tech industries, in contrast with a slower pace of domestic demand dragged by a structurally constrained property sector.
- The on-going US/Israel and Iran war adds additional layer of challenge to China’s recovery ahead. We consider two scenarios: scenario 1, should the trade disruption in the Strait of Hormuz ends before the end of March, we expect Brent crude price to decline in Q2 and the quarterly average price in Q2 to return back to around USD80 per barrel and persist for the remaining year - this could squeeze China’s GDP by about 0.2%; scenario 2, a riskier scenario with trade disruption persisting into Q2, and further escalation in oil prices to an average of USD120 per barrel in Q2 before declining to USD80 per barrel by the end of this year, due to cut in production and depletion in inventory - this could translate into a 0.5~0.6% drag on GDP. Based on our prior forecast of 4.9% growth for 2026, scenario 1 and 2 imply a 4.7% and 4.3% GDP growth respectively for 2026.
- Lately, USD/CNY displayed certain resilience following the outbreak of the US/Israel and Iran war, with the PBOC’s support of active fixing management. Looking forward, for scenario 1, we maintain our forecasts of USD/CNY to be 6.85 by end Q1 and Q2, and 6.80 by end of 2026 unchanged, due to potential increasing diversification demand for Chinese assets incurred by the Middle East war and its geopolitical implication, despite stress on the Chinese economy. For scenario 2, we expect USD/CNY to be 7.10 by Q2 and 6.90 by year-end. CNY is likely to be better insulated from supply shocks, compared with major Asian currency peers, benefitting from relative high energy self-sufficiency, its large strategic petroleum reserves, and diversification in sourcing.
