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Yuan devaluation sparks fears

Whether or not China is actually mulling more CNY weakness to support exports is moot, as what moves the financial markets are sentiments around the perception of what will more Yuan depreciation mean for other economies.

USD & Yuan
Source: Bloomberg

USD/CNY mid-point fixing has seen a larger magnitude at the start of the New Year, and Wednesday’s fixing weakens the CNY by 0.22%, compared to the previous day’s fixing. This was the lowest CNY fix since April 2011. Today’s fixing cuts yuan by a substantial 0.5%. That clearly pandered to the market fears of a currency war triggered by yuan devaluation.

According to Bloomberg calculations, yuan is rather stable when you compare it to a basket of currencies comprising China’s major trading partners, instead of just to the US dollar. It just does not make sense for China to, for no apparent good reason, spark off a fresh round of competitive currency devaluation.

Yuan has appreciated more than the dollar since December 2010, and the gap remains. Looking at the Morgan Stanley data, the RMB has gained around 30% since August 2011, while the US dollar was up about 27% or so. 

Moreover, there are no fundamental reasons to believe that the yuan will persistently depreciate in the future because China still runs a massive current account surplus. Weak energy prices should also help increase this surplus, provided demand stays the same.

Chinese officials have repeatedly pointed this out over the last year, and when the PBOC shifted to a multi-currency peg for the yuan from the USD-CNY peg previously. The broader gauge is a more accurate indicator of the value of the yuan.

I feel that the misunderstanding boils down to communications of its policies. To the external media, it seems like a flip-flopping of policy making, and that would hurt foreign investor sentiment. But as we have seen in the Fed’s attempt at improving communications, the markets continue to speculate on every piece of information, or data.

The upshot is that better communications do not necessarily translate into more clarity or less market volatility. The converse might actually be more prevalent. Perhaps there is a balance between too little communications and too much communications, which belies the difficulty and challenges that policy-makers have to face on a regular basis.

For now, it may seem like the tweaks that Beijing make will continue to affect global market mood, while it continues to find its footing in calibrating the domestic capital markets. As long as markets continue to hold the view that China is inclined to devalue the yuan further, we will see worries of lesser purchasing ability from China as well as fears that other economies may start weakening their currencies, sprouting a currency war.

 

Markets

  • S&P 500 slumped below key 2000, dropped -1.3%. Dow lost 252 points, and fell -1.5%. European indices fared the same. DAX declined -0.9% while CAC 40 and FTSE lost over 1%. The Euro Stoxx 600 was lower by -1.3%.

 

  • Developed sovereign bonds continued to gain. 10-year yields dipped almost 7 basis points.

 

  • PBOC sets a higher USD/CNY midpoint fixing, up about 0.5% to 6.5646. The pace of weaker yuan fixing seemed to have accelerated this week. Commodity currencies dropped in reaction. AUD/USD fell -0.5% at last check.

 

  • The dollar index remained above 99, pushing EUR/USD and USD/JPY lower. EUR/USD went below 1.08 while USD/JPY fell towards 118.

 

  • China stocks halted for rest of Thursday, after CSI 300 tumbled 7% in the first hour of trading.

 

*For more timely quips, you may wish to follow me on twitter at https://twitter.com/BernardAw_IG

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