Da Cheng

The overarching theme for China's market in 2026 is expected to be "price recovery → earnings repair → valuation reassessment."​ Macroeconomically, the deflationary trough is likely behind us. 

For the currency, fundamentals support RMB appreciation. In equities, the dual pillars of earnings growth and valuation support are falling into place. Against a backdrop of global portfolio rebalancing and China's ongoing economic transition, the A-share market warrants close attention from global investors.

The Federal Reserve is projected to initiate a sustained easing cycle in 2026. Our baseline scenario assumes three consecutive 25-basis-point rate cuts throughout the year (totaling 75 basis points), with the core policy focus pivoting towards a combination of "growth stabilization and liquidity easing." This shift is anticipated to provide a more favorable macro environment for Asian credit markets.

This prospective policy pivot is expected to positively impact the market through three channels: liquidity and valuation, credit supply-demand dynamics, and spread movements. Overall, supported by a more accommodative monetary environment, the Asian USD bond market—particularly the global high-yield sector—is poised to demonstrate greater resilience and present relatively attractive allocation opportunities for investors in 2026.

China Equity Market Investment Outlook 2026

I. An Economic Turning Point: From Deflation to Moderate Re-inflation

The Chinese economy is showing tentative signs of a critical inflection point following a three-year deflationary phase. The core issue has shifted from a lack of demand to elevated real interest rates, a phenomenon inherent to a deflationary environment. Consequently, the policy priority is pivoting towards "price stabilization" to normalize real interest rates, moving beyond pure quantitative expansion.

Policy measures initiated in 2025 aim to counter deflationary pressures, with the deceleration in manufacturing fixed-asset investment signaling a potential end to the cycle. The upcoming recovery is anticipated to be driven by a confluence of supply and demand factors:

• Supply-Side Rationalization:

Since mid-2024, "anti-involution" policies have taken center stage. Key directives from top-level meetings emphasize curbing disorderly low-price competition, eliminating obsolete capacity, and fostering a unified national market. Even without policy intervention, widespread corporate losses and constrained capex capacity have made the old "volume-over-value" model unsustainable.

Figure 1: Monthly Loss-Making Enterprise Ratio (%)

Figure 2: TTM YoY Growth in Capital Expenditure: All A-Shares (Excluding Financials & Petrochemicals) (%)

• Demand-Side Support: Global Fiscal Impulse and Lean Inventories

Major global economies may be entering a synchronized fiscal expansion phase, as indicated by rising OECD leading indicators. Concurrently, inventory levels across China, the US, Europe, Japan, and South Korea are at historical lows, setting the stage for a demand uptick driven by inventory restocking.

Figure 3: Inventory Cycle Positions: China, the US, and Europe

Figure 4: Inventory Cycle Positions: Japan and South Korea

• PPI: A Key Indicator Bottoming Out

The return to positive month-on-month PPI growth in October 2025 marks a positive turn. Buoyed by supply-side reforms, recovering external demand, and stable commodity prices, the PPI is forecast to see improving year-on-year growth throughout 2026, turning positive by Q4. Price recoveries in non-ferrous metals and silicon materials, alongside stabilization in sectors like new energy, will be key catalysts.

Figure 5: Copper Prices Recovery to Support PPI

Figure 6: Polysilicon Price Recovery to Support PPI

Macro Summary:

The Chinese economy appears to be stabilizing, with tail-risks of a sharp downturn receding. The focal point for the next phase is the trajectory of inflation, particularly the PPI, which is pivotal for restoring corporate profitability and lowering real interest rates.

II. RMB Exchange Rate: Fundamentals Point to Strengthening

Exchange rate dynamics are closely tied to inflation trends. As deflationary pressures in China abate and nominal GDP growth expectations rise, the fundamental case for the RMB is improving. Notably, the RMB has demonstrated resilience, appreciating against the USD even during periods of dollar strength in H2 2025, highlighting its inherent momentum.

• Exporters' FX Settlement Intentions Rebounding: 

A key support factor is the increasing willingness of exporters to settle foreign exchange receipts. As consensus around a "strong dollar" weakens and the Fed's easing cycle begins, accumulated overseas FX proceeds are expected to repatriate. A normalization of the FX settlement ratio to its historical average would provide sustained inflows for the RMB.

Figure 7: China's Export Foreign Exchange Settlement Ratio (Past 12 Months, %)

• 2026 Exchange Rate Outlook:

Consensus forecasts suggest the RMB/USD rate could appreciate beyond the 7.0 level in 2026. This trend is expected to be complemented by a potentially weaker USD index and improving cross-border capital flows for China. 

Figure 8: USD/CNY Exchange Rate vs. USD Index (Jan - Nov 2025)

III. A-Share Market: A Dual Engine of Earnings and Valuation

Recovery

A bottoming PPI sets the stage for a potential "double boost",earnings recovery and valuation re-rating for the A-share market.

• Earnings Recovery: From Contraction to Expansion:

Historically, A-shares have delivered positive returns during PPI turnaround cycles. As pricing power improves and margin pressures ease, overall A-share (non-financial) profits are projected to achieve double-digit growth in 2026, ending a multi-quarter earnings slump.

Table 1: Historical A-Share Performance During PPI Turn-Positive Periods

• Valuation Re-rating: Risk Appetite Returns:

The end of deflation implies a lower Equity Risk Premium (ERP). The high ERP seen in 2023-2024, driven by pessimism, is receding as deflation fears wane and policy clarity improves. Supply-side reforms like "anti-involution" enhance long-term economic quality. Further PPI recovery could drive additional valuation expansion.

Figure 9: CSI 300 Equity Risk Premium (ERP)

• Liquidity: Tapping into Domestic and Foreign Flows:

1.Foreign Inflows & FOMO: China's competitive stance in sectors like AI and new energy challenges the "There Is No Alternative" (TINA) narrative favoring the US. A confluence of A-share earnings recovery and RMB appreciation in 2026 could trigger "Fear Of Missing Out" (FOMO) driven foreign inflows. 

2.Domestic Liquidity Rotation: Significant mainland capital allocated overseas could repatriate. Simultaneously, high household deposits may continue shifting towards equities, given the lack of attractive yield alternatives.

Figure 10: Chinese Capital Holdings of U.S. Stocks

• Key Beneficiaries: Mid/Upstream Sectors:

Historical evidence suggests mid and upstream sectors typically exhibit greater earnings elasticity and outperform during PPI recovery cycles, benefiting directly from improving prices.

Table 2: Relative Performance of Market Sectors Across PPI Recovery Cycles

­­­Offshore Bond Investment Outlook 2026

I. 2026 Rate Cut Path and Easing Rationale 

• Baseline Path of Three Rate Cuts

The Fed is anticipated to remain in an easing cycle during 2026. We base-case expect three separate 25 bp rate cuts over the year, resulting in a cumulative 75 bp reduction in the policy rate from current levels by year-end. Against this backdrop, we project the 2-year, 5-year, and 10-year U.S. Treasury yields to decline to approximately 2.8%, 3.2%, and 3.7%​ respectively by the end of 2026. The yield curve is expected to experience a moderate steepening, reflecting both market expectations for persistent easing and an increased term premium demanded for U.S. Treasuries.

• Core Drivers for Sustained Easing

1.Controllable Inflation:​ Inflation has entered a sustainable downward trajectory. The Core PCE index is forecast to average near the Fed's 2% target in 2026, providing sufficient room for continued rate cuts. 

2.Soft Landing for the Economy:​ The U.S. economy is projected to experience a "moderate slowdown while avoiding recession." Weakness in traditional economic sectors is expected to outweigh the growth momentum driven by emerging industries like AI. Consequently, the Fed needs to employ sustained easing policies to hedge against downside growth risks and prevent the economy from falling into a low-growth trap.

II. Diminished Policy Uncertainty and Easing Continuity

• Dovish Bias in Key Variables.

1.Limited Impact from Leadership Change:​ The appointment of a new Fed Chair in 2026 is unlikely to alter the primary dovish policy stance. Monetary policy will continue to focus on economic fundamentals, with the new team likely leaning towards sustained liquidity support to consolidate economic recovery. This suggests enhanced policy continuity rather than disruption. 

2.Data Volatility Doesn't Alter Direction:​ Short-term fluctuations in macroeconomic data (e.g., temporary economic rebounds or minor inflation upticks) will not change the broader easing direction. The Fed will adopt a model of "gradual easing coupled with flexible fine-tuning" to avoid market turbulence caused by abrupt policy shifts.

• Transmission Logic of Easing Policies

The Fed's policy focus has shifted from balancing "curbing inflation" against "supporting growth" to prioritizing "maintaining economic recovery momentum." The controllability of core inflation allows policy to concentrate more on underpinning the economy through accommodation. We expect this easing cycle to extend into 2027, implying further room for rate cuts after the three moves in 2026, ultimately forming a prolonged environment of "sustained easing + low interest rates."

III. Positive Implications for the Asian Credit Market

• Liquidity and Valuation Support

1.Global Liquidity Shift:​ The Fed's sustained easing will significantly reduce the pressure for capital to flow back into U.S. dollar assets. Instead, it could attract global liquidity towards the Asian credit market, which offers higher yields and growth potential. This should help contain the extent of significant credit spread widening. 

2.Lower Financing Costs:​ Ample USD liquidity will reduce overseas financing costs for Asian issuers. The carry advantage of Asian high-yield bonds​ will become particularly more pronounced, helping to support resilience in their total return performance.

• Optimized Credit Supply-Demand Dynamics

1.Orderly Increase in Supply:​ Expectations of a prolonged low-interest-rate environment will encourage Asian companies to expand their overseas bond issuance, leading to orderly growth in primary market supply. 

2.Stronger Demand:​ Demand is anticipated to be even more robust. Both regional funds (accounting for approximately 80% of Asian credit demand) and global capital are expected to increase their allocations to Asian credit, particularly in medium-to-long duration tenors. This will further support a steepening credit curve, especially benefiting 7-10 year investment-grade bonds and 2-4 year high-yield bonds.

IV. Forward-Looking Spread Analysis

As of November 2025, credit spreads for both Chinese investment-grade (IG) dollar bonds and the broader Asian IG dollar bond universe are at historical lows, suggesting very limited room for further compression. Coupled with expectations for a moderate increase in primary market supply for Asian USD bonds in 2026, we judge that spreads for Chinese IG and broader Asian USD bonds could experience a modest widening​ in 2026.

Figure 1: Spread Analysis: Asian vs. Chinese Investment-Grade USD Bonds

Regarding the high-yield (HY) dollar bond sector, we hold a relatively more favorable view on global high-yield dollar bonds​ compared to the Chinese HY dollar bond segment, given the latter's currently relatively small size and weaker liquidity. While the spread of the global high-yield bond index is also at historically tight levels, supported by the Fed's potential easing and expectations for a global soft landing leading to stable corporate credit fundamentals, global HY spreads are expected to remain stable or even narrow slightly. Consequently, global high-yield bonds are anticipated to outperform their investment-grade counterparts. Furthermore, from an absolute yield perspective, global high-yield bonds also appear attractive due to their higher coupon income.

Figure 2: Global High-Yield Bond Index Spread