M2 growth remained flat at 8.3% YoY in May, lower than the market consensus of 8.5% YoY. On a sequential, seasonally adjusted basis, M2 growth stayed flat at 0.3% MoM in May. Fiscal deposits increased by Rmb386bn in May, Rmb169bn less than the Rmb555bn increase in May 2017, lifting the M2 growth by ~0.1ppt. Meanwhile, the YoY growth of fiscal deposits declined to 13.4% YoY in May from 19.4% YoY in April but remains faster than money supply and nominal GDP growth. May M1 growth declined further to 6.0% YoY from 7.2% YoY in April, while sequential M1 growth dipped into negative territory at -0.2% MoM in May from 1.1% MoM in April – negative sequential M1 growth indicates notable tightening of cash flow positions of the corporate and/or government sector.

New RMB loan issuance came in at Rmb1.15trn in May, marginally higher than Rmb1.11trn in May 2017. Loan growth edged down to 12.6% YoY in May from 12.7% YoY in April. Among new loans, new medium-/long-term loans came in lower YoY for both the household and the corporate sector, while the share of short term loans continued to rise, which indicates dampened end-demand due to policy tightening. New M/L term household loans increased by Rmb392bn in May 2018, lower than Rmb433bn in May 2017; new M/L-term corporate loan issuance came in at Rmb403bn in May, compared with Rmb440bn in May 2017. Meanwhile, net increase of short-term loans and bill-financing rose to Rmb308bn in May, higher than Rmb278bn in May 2017.

New total social financing (TSF) came in at Rmb761bn in May, notably lower than Rmb1.06trn in May 2017 and the market expectation of RMB 1.3 trillion. Within TSF, new issuance of non-standardized assets (NSA), including trust loans, entrusted loans and banker’s acceptance bills, continued to decline and visibly dampened overall TSF growth– the three NSA items combined declined by Rmb422bn MoM in May, compared with Rmb29bn MoM net increase in May 2017. Furthermore, new corporate bond issuance declined MoM, as the increase in credit default events severely dampened risk appetite and pushed up credit spread – total corporate bond financing outstanding declined by Rmb43bn in May, which stands in sharp contrast with the Rmb378bn net increase in April. However, credit bond stock also shrunk in May 2017 by Rmb249bn, which at the time was (also) induced by tightened financial conditions amidst a step-up in “deleveraging” efforts.

Financial conditions tightened notably in May, with regulatory tightening keeping both NSA credit demand & supply at low levels, while credit bond market volatility added to the tightening impulse as well. More specifically,

YoY Adjusted TSF growth declined notably to 11.6% YoY in May from 12.1% YoY in April (Adjusted TSF = TSF + local & government bonds). On a sequential, seasonally adjusted basis, adjusted TSF growth decelerated visibly again to 8.6% MoM annualized in May from 11.7% in April (which closely followed the ~5% MoM annualized growth in March). It is worth noting that not only did reported TSF disappointed in May, both local government bond and treasury bond net issuance have decreased notably YoY, adding to the weakness in adjusted TSF growth.

M2 Proxy growth may have also declined visibly in May. Assuming 0% sequential change of PBoC FX positions, we estimate that the M2 Proxy growth may have decelerated further to 10.2% YoY in May from 10.5% YoY in April.

Meanwhile, money market rates edged down in May. The weighted average interbank offered rate and pledged repo rate edged down by 9bp and 28bp to 2.72% and 2.82% in May, respectively.

Financial conditions tightened notably (again) in May, closely following the visible tightening in March. We reiterate our long-held view that overly-restrictive financial conditions may only serve against the long-term goal of deleveraging. The combined effect of elevated pressure for NSA “standardization” and the credit bond market volatility has led to harsher-than-expected monetary condition tightening in May, again. Sequential annualized adjusted TSF growth fell to single-digit, indicating contractionary effect on investment demand with a lag. In our view, the faster-than-expected monetary and fiscal policy tightening may have also started to dampen corporate cash flow and raise funding cost for the real economy, esp. for the SMEs and private enterprise. On the fiscal front, although it appears that fiscal reserve dispersion has accelerated somewhat in May, fiscal deposit growth continues to outpace that of total deposits and nominal GDP. In our view, the recent credit bond market volatility is largely a manifestation for the “side-effect” of the overlapping policy efforts targeting deleveraging. It is worth reiterating that nominal growth and cash flow of the real economy respond to tightened financial conditions with a time lag – although the “leverage ratio” may not be rising at the moment, it may resume its climb when nominal GDP growth decelerates as a delayed reaction to overly restrictive financial conditions and the corporate sector resorts to bank credit to bridge the gap of operating cash flow. Therefore, we maintain our long-held view that that real-economy-deleveraging will likely progress much more smoothly with neutral policy settings, where operating cash flow and the reflation expectation can be sustained. The rising credit market risk premium serves as a reminder that it is crucial to stabilize the expectation of growth, inflation, and funding cost to prevent the formation of new risk-factors during the process of deleveraging. From a medium-term perspective, financial deleveraging cannot succeed without corresponding fiscal, institutional, and market reforms.