Europe
European markets fell into the red on Tuesday after China’s surprise devaluation of its currency sent shockwaves through commodities and the shares of companies which heavily rely on trade with China.
China’s renminbi has been dragged higher in the last twelve months despite an underperforming economy because of its peg to the US dollar, which has been gaining on expectation of higher interest rates in the United States. A stronger renminbi contributed towards a slump in Chinese exports in July so Chinese authorities have addressed the issue directly through currency devaluation to make China’s exports relatively cheaper abroad.
On the flipside, European exporters including luxury goods-makers and automakers have over the past year been enjoying the trade benefits of a cheaper euro versus the Chinese yuan, which has cut the cost of their products in China. The People’s Bank of china has described the intervention as a “one off” but the reason equities are falling so sharply is because of the fear that this is China’s entrance into a currency war to make its exports more competitive again.
Greece has agreed on the terms of a third bailout package with its creditors but the news has been brushed to the sidelines because of the news from China. Markets rallied on Monday after talk circulated that a deal was near-done. It is however an outline for a deal, so more detail is needed and a few more hurdles need to be jumped.
Given the current desperate state of Greece’s economy, creditors have caved-in on budget surplus requirements, formerly a big sticking point in negotiations. 2015 is forecasted to see a budget deficit of -0.5% while the surpluses expected in 2016 and 2017 are significantly reduced. The first tranche of new bailout funds look like they will be released in time for theaugust 20 payment to the ECB. Greece needs to implement as many as 35 “prior actions,” the term used for immediate reforms that must be passed by law in Greece, and national governments must vote on the agreement.
US
US stock markets opened lower alongside Europe and the rest of Asia after China devalued its currency.
Broadly the reaction to China’s devaluation has been that of a risk-off move into gold and treasuries, simply because it was unexpected. The move into treasuries and the resulting lower treasury yields may also reflect a belief that the action from the PBOC makes monetary tightening from the Fed more difficult. A devalued yuan makes the dollar stronger, further weighing on US exporters and is also a reaction to China’s weak economic position which is a negative for global growth.
FX
The most important move in FX markets was the biggest one-day jump in the value of the US dollar versus the Chinese yuan in two decades. The daily fix for USD/CNY moved from 6.2298 to 6.1162, 1.9% higher.
The exchange rate for the euro versus the offshore yuan, EUR/CNY gained over 3.5% resulting in a strong EUR/USD. The euro appreciated more than the dollar versus the yuan because, if this is an effort by the Chinese at competitive devaluation, it is aimed at Europe and Japan, not the US.
The latest export figures from China showed relatively stable trade with the US but it was trade with Europe and Japan that really suffered. It’s no coincidence that both the euro and Japanese yen have both weakened significantly against the Chinese yuan in recent months because of quantitative easing from the ECB and BOJ. A 2% adjustment in the trading band is not enough by itself to make a major difference to foreign trade. The fear is that this move from the PBOC is the first shot from China in the currency war.
It is not entirely certain that Chinese policymakers have shifted to stimulating the economy through a weaker exchange rate. A strong currency prevents capital outflows that could destabilise the economy and also helps the political objective of the IMF including the yuan in the basket of currencies that make up its SDRs.
The dollar’s sudden bout of strength versus the renminbi reverberated across other major currencies. The Aussie and Kiwi dollar saw the biggest losses given the reliance of the Australian and New Zealand economies on trade with China.
Plunging oil prices saw the Canadian dollar drop back in value towards multi-year lows. USD/CAD rebounded off 1.30 back above 1.31.
Commodities
Industrial metals including copper were sold off heavily on Tuesday as the US dollar strengthened against the Chinese renminbi. Copper had rallied off multi-year lows on Monday to above $2.40 per lb but almost all of the gains were undone on Tuesday.
Gold and silver both broke higher from tight trading ranges as investors moved into safe-havens after the shock decision by the PBOC to intervene in the FX market, with gold rising as much as $20 to as high of $1,120 per oz.
The initial reaction amongst commodities was to drop because of the rising dollar. That move could get reversed given the stimulus the devaluation could provide to China’s economy. If the devaluation does have a material benefit to the economy, it may reduce the need for infrastructure development which could be a net negative for commodity demand in the long run.
OPEC’s monthly report showed Saudi Arabia produced less oil during July, well below the record output last month but other countries within the cartel including Iran, Iraq and Angola have increased overall production. Iran is now producing the most since sanctions were tightened against it in 2012 but will not substantially increase output until sanctions are confirmed to have been lifted. Brent crude is now back beneath the key $50 per barrel that is had closed above on Monday.
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