China devalues yuan – what does it mean for investors?

11th August 2015

Clifford Lau, head of fixed income, Asia Pacific at Columbia Threadneedle Investments examines China’s decision to devalue the yuan to a three-year low against the US dollar…

The 2% depreciation of the Chinese yuan (CNY) fixing on Tuesday sent a shockwave across regional Asian currency markets, especially those countries dependent on export competitiveness to deliver growth, such as South Korea, Singapore and Taiwan.

It is still unclear whether the announcement by the People’s Bank of China (PBoC) of a more market-driven approach to set the daily fixing of the yuan will bring about further weakness in the coming days, given that the mechanism has not been tested. However, judging by how the rest of the market moved today, CNY should be set to be fixed even higher tomorrow.

Running the real effective exchange rate analysis of the leading trading partners in Asia, the yuan has more room to correct in order to regain its relative FX competitiveness.

This PBoC’s surprise move came after several consecutive months of weak Chinese economic data prints from export markets and industrial production, signs of PPI deflation, and the rout seen in the equity market.

The stock market volatility also meant the government had to supply new loans to the financial sector to prevent a nosedive, much to its reluctance. We think the PBoC’s move could have longer-lasting effects for the future path of Asian FX as the export growth of the rest of Asia has been alarmingly disappointing. Lingering US dollar strength and the potential US interest rate ‘lift off’ in September/December could create a double whammy which will weigh further on Asian FX.

We think today’s CNY move is remarkable as it immediately addresses China’s relative currency richness versus its neighbours. It should also help to spin the conversation to China’s advantage when applying for the yuan to be incorporated as Special Drawing Rights with the IMF.

Leave a Reply

Your email address will not be published. Required fields are marked *