What’s next for China’s financial markets?

Investing.com -- After a recent stretch of underperformance, China’s equity market has bounced back, even as risks tied to trade tensions and industrial overcapacity persist.

According to Capital Economics, sentiment toward Chinese equities may be improving, helped by easing U.S. chip restrictions and more visible engagement from Beijing to address price wars and overcapacity concerns.

Until recently, China’s stock market had lagged global peers, particularly in technology sectors. Much of the Q1 outperformance in tech shares had been unwound amid fears over tariffs, export controls, and domestic supply gluts.

However, “the easing of U.S. restrictions on high-end chip access seems to have helped lift ‘tech’ stocks,” Capital Economics said in a Monday report, adding that renewed urgency from Chinese policymakers—“including President Xi himself”—on economic rebalancing may have supported gains in consumer discretionary names.

The macroeconomic research firm expects the market to continue performing well, pointing out that valuations remain low.

“Sentiment around China’s equities still seems quite downbeat, judging, for example, by their low relative valuations,” it said. The report suggests that despite investor caution, there is room for sentiment to improve “even if there are no significant game-changers.”

The firm also flags supportive policy developments, particularly for the technology sector. “We suspect the ‘tech’ sectors will receive a further boost from the ongoing supportive policy shift that’s given the private sector a greater role in the authorities’ strategic technological goals, especially around AI.”

Overall, Capital Economics continues to expect MSCI China to outperform MSCI EM in the coming year, though still lag the U.S. and global indices.

On the fixed income side, the outlook is less constructive. Earlier expectations for deeper rate cuts have been scaled back. The People’s Bank of China is seen as wary of encouraging deflationary dynamics driven by overcapacity, particularly if cheap credit prolongs the life of inefficient firms.

“We now expect rate cuts to be more gradual than we’d previously thought,” the report continued.

As a result, Capital Economics now sees the 10-year bond yield ending 2025 at 1.65%, versus an earlier call of 1.40%.

As for the Chinese currency, the renminbi has remained stable despite new tariff threats. Capital Economics believes this will continue but sees room for modest depreciation through year-end.

It forecasts the renminbi to weaken to 7.35 against the dollar by year-end, from its current level of 7.18.