The Yuan devaluation should not be a surprise. Why the markets reacted negatively?
Markets never like surprises. Investors always try to be prepared about the major credit events and financial shocks and not coincidentally, financial engineering has invented the derivatives and many other products to protect investors from possible strong fluctuations of their investments. That’s why the Fed and the ECB try to be very transparent in their communications and decisions to the markets, and certainly tries to price their decisions before they are taken. But, unfortunately the Peoples Bank of China continues to make decisions without creating expectations. The same did the Central Bank of Switzerland when decided to drop its currency peg with the euro, creating a massive shock in the Forex market and forcing to bankruptcy many big brokers of the sector. On our opinion it was unforgivable.
In the time of currency war that we live, the Yuan devaluation of this week shouldn’t be such a big surprise for the markets. Everything started Tuesday when the PBC decided a 1.9% devaluation of its currency. Markets reacted brutally, losing capitalization all around the globe because they had no idea what was going on and if the Bank of China’s interventions were finished. On Wednesday there was a second devaluation of 1.6% but at the same time, the Central Bank communicated that this should have been something very manageable and the markets finally found a bit of calm. On Thursday there was a third Yuan devaluation of 1.1% and Friday there was even a revaluation of the Yuan of around 0.6% at a rate of 6.4 against the USD from 6.45 of the day before. Summarizing, it was a 4% devaluation in one week of the Chinese Yuan against the USD.
If markets would have had a certain expectation before that decision was taken, probably we wouldn’t be here to analyze this event and also the major TV and newspapers would not have spoken and written all those words and sparked worries and panic in investors’ minds. This Yuan devaluation was the major argument discussed between analysts this week, while nobody talked with the same panic about the 20% depreciation of the Japanese Yen, the 20% depreciation of the New Zealand dollar, the 20% depreciation of the Australian dollar against the USD, not speaking here about the even higher depreciations of the Turkish lira (30%), Brazilian Real ( 50%) and the Russian ruble (80%) versus the USD.
Effectively the USD has been strengthening against all the currencies during the last year. At the same period the Yuan appreciated versus the USD maintaining its trend, started years before. Now, at this point when every Central bank is part of a world-wide currency war, why shouldn’t the PBC be part of it.
Many analysts now talk about a possible 10% devaluations of the Yuan in the coming days or weeks, following basically the same trajectory, as the economy growth in China has definitely slowing the pace. Global demand is not so strong for the moment and the world’s factory has also slowed down. However, China’s current account continues to remain strongly positive and that’s the reason why Chinese officials should take it very gradually.
One of the major effects, this decision had on global markets, was to further deteriorate of the commodity prices, as a weaker Yuan will make the prime materials even more expensive for the Chinese industry with a possible reduction of the demand. The Bloomberg Commodity Index reached this week its lowest level from the invention, even lower than the 2009 collapse.
Many analyst are also talking about a possible delay of the rate hike by the Fed, after the Chinese decision to devaluate. On our opinion this has fewer chances to happen because we believe there is no way for the FED, to further delay the rate hike.