Was the CNY devaluation a once-off deal?
Global Markets Calm after Subdued Yuan Slide
Global currency markets have been rocked by fears of further declines in commodities prices following the Chinese Yuan devaluation on Tuesday, 11 August. In the weeks leading to the People’s Bank of China 2% devaluation of the CNY, commodities prices across the board were facing increasing pressure. Demand from the world’s second-largest economy had flattened out, and recently released data on imports, exports and GDP growth were disappointing. Emerging market economies, notably South Africa, Turkey, Brazil, Argentina and others continue to feel increasing pressure in their mining sectors as the price of copper, coal, gold, platinum and other commodities face bear markets.
The Chinese government has been focusing on a shift away from export-driven growth to growing domestic demand. However the Chinese Central Bank decided not to sit idly by as the economy sputters. Government intervention by way of a devaluation of the currency was aimed at improving China’s export potential. However, since most commodities are priced in US dollars, a devaluation of the CNY also means that China’s ability to purchase commodities on global markets will be limited by the relatively higher cost. It must be remembered that Chinese exporters have been steadily losing ground to their competitors as China’s economy continues to take hits. China’s main competitors in Asia include Japan and South Korea whose currencies have both appreciated against the USD in 2015.
Further Chinese Yuan Devaluations Expected
It’s entirely possible that policymakers in China want the currency to decline by as much as 10%, but they are unlikely to have this happen in 2% increments. By Wednesday, 12 August, the CNY was trading at 6.39 to the USD – a weakening of 1%. Key market players are expecting a further weakening of the CNY to take place over the next year, and the market is as volatile as ever. The People’s Bank of China will likely continue selling dollars in an effort to cause an appreciation in the Chinese Yuan (in the short-term) – this is how the Chinese government stabilises the cross currency exchange rate. It also explains why the CNY decline has been more subdued in recent days. Since the Chinese Central Bank does not allow the currency to find equilibrium through market forces alone, government intervention is essential to determining its value on the market. In July, Chinese exports declined by 8.3% owing to slack global demand. U.S. lawmakers believe that the Chinese government is attempting to grab a greater slice of the export markets through its latest currency devaluation. Sentiments are mixed from major market players, as the International Monetary Fund (IMF) welcomed the move.
The big story on everyone’s minds is the impending Fed rate hike in September. If the US Federal Reserve decides to increase interest rates, this will cause the dollar to appreciate and cause further downward pressure on commodities prices. Since emerging market economies are most likely to be impacted by plunging commodity prices, their currencies will decline too. South Africa which was once front and centre the leading global producer of gold and major other commodities has since slipped into sixth position in global rankings. Plunging commodity prices, weak global demand and rising costs are but a few of the factors that have sent this currency (ZAR) into a tailspin. The South African Rand is currently trading around R12.80 to USD, R14.20 to the EUR, and approximately R19.90 to GBP.
BRICS countries will suffer with a Stronger USD
When the Fed decides to raise interest rates, global markets will invariably be impacted in a negative way. Since this will be the first interest-rate hike in 9 years, the effect on emerging market economies will be notable. Now that the CNY is currently trading at a devalued rate, a hike in US interest rates will make the U.S. Dollar even more expensive relative to the CNY. This may give policymakers pause in deciding upon the scope and timing of the interest-rate hike. Since China owns the vast majority of U.S. debt, the brains trust in the U.S. may not be too eager to make U.S. products more expensive for export purposes while Chinese products become relatively cheaper on global markets. The combination of a weak CNY and a strong USD will prove too much for the global economy. This is especially true for BRICS (Brazil, Russia, India, China and South Africa) countries and other emerging market economies.
Markets are Sentiment Driven
In the days following the CNY devaluation, some stability has returned to emerging market stocks. Since the Chinese government is intricately involved in maintaining a stable currency, the sharp declines that many expected simply did not come to pass. The emerging markets stock index on the MSCI gained 0.7% and the Shanghai Composite index also spiked 1.8%. This positive sentiment is largely the result of comments made by the People’s Bank of China to the effect that the fundamentals of the Chinese economy are strong and no further devaluation of the currency is warranted. In South Korea and Malaysia, policymakers from the central bank kept benchmark interest rates at their present levels. Even the Russian ruble managed to claw its way back against the USD, gaining 0.4%. Owing to rising Brent crude oil prices, dollar-denominated equities also gained 0.7%. Banc De Binary experts maintain that while it appears that a CNY devaluation and the possibility of a rate hike in the US are bad for business in emerging market economies, there is more at stake.
How are Emerging Currencies Performing to Date?
Emerging market currencies have largely performed negatively in 2015 with the exception of several currencies that have appreciated. These include the Russian ruble (+10.2%), the Taiwan dollar (+4.8%), the Indian rupee (+3.4%), the Polish zloty (+0.7%, the Argentinian peso (+0.4%) and the Singapore dollar (+0.3%). The currencies that have been impacted hardest by market movements include the Brazilian real (-11.3%), the Turkish lira (-6.6%), the Mexican peso (-4.3%, the Indonesian rupiah (-3.9%), the South African Rand (-2.4%) and the Korean won (-1.8%). The aforementioned data was provided by Thomson Reuters as at 16 July 2015. We can expect these figures to look dramatically worse if a September rate hike takes place and commodity price declines persist on global m