Foreign Exchange
China shocked the markets last week by devaluing its currency against the US Dollar on 3 successive days. Unlike most currencies, the Chinese Yuan does not trade freely in the foreign exchange markets. The People’s Bank Of China keeps its value against the Dollar within a 2pc range of a “reference rate”. That reference rate was adjusted and the Yuan fell 3pc and a further devaluation has not been ruled out.
In the grand scheme of things this is not a large currency move. Between mid 2000s and 2013 the Chinese authorities allowed the Yuan to rise by about a third against the US currency. But the latter has been strong this year against a wide selection of currencies including some of China’s key competitors in Asia e.g. South Korea and Indonesia. Keeping China’s peg to the USD has made its economy less competitive in a wide range of markets in Europe and Asia and the recently reported fall in the value of Chinese exports is evidence of this.
China’s economy is slowing partly because of the change in structure of the Chinese economy to a more consumer and service driven model but the Chinese authorities want to avoid a hard landing and allowing the currency to depreciate is one tool at its disposal to head off this risk.
Equities
Equity markets were shocked by the move falling in the region of 2% with share prices of companies that are either commodity based, or have large exports to China, being hardest hit. Commodity based companies fell because the move indicated further concern over the health of the Chinese economy which historically has had huge demand for a wide range of global commodities. Although US and European markets fell, the Shanghai stock market rallied strongly, rising from 3,600 to 4000 as the Chinese authorities continue to support the market as demonstrated by this currency move.
Fixed Income
Bond markets around the world remain well supported as investors bought debt as a ‘safe haven’ play. Bonds often behave like this when there is any surprise global news or volatility in equity markets. Two year German Government Bonds or ‘Bunds’ yield minus 0.25% i.e. investors will receive less money back than they invest if they hold this bond until maturity. Why would an Fund Manager buy such an instrument? Two reasons: Firstly,German Government debt is one of the most secure investments in the world. Investors have the assurance that debt repayment will be unproblematic with no risk of significant loss. Buying the Chinese equity market today an investor could make or lose 30% within 3 months! Secondly, some funds are only allowed to buy high quality Government Bonds and if the yield is minus 0.25% then so be it. They cannot diversify into Corporate Bonds or other assets.
Interest Rates
The Chinese currency move may have pushed back expectations on the timing of a rise in US interest rates. Most economists had been looking for the US Federal Reserve to raise interest rates in September. One of the motivations for raising interest rates is to prevent future inflation. However, we have recently seen a significant fall in commodity prices which has been extended since the devaluation. Chinese goods themselves will become cheaper as the US dollar now buys more Chinese Yuan again lowering the cost of imports and therefore non-inflationary. Note: Any US rate move should not be dramatic with the debate over a 0.25% interest rate rise from historically low levels.
Equities
S&P 500: 2110
Nasdaq: 5100
Bonds – 10 Year Government Yields
US 2.15%
EU 0.64%
GB 1.82%
Foreign Exchange
USD/EUR 1.1080 (1 euro buys 1.1080 dollars)
GBP/USD 1.5600 (1 pound buys 1.5600 dollars)
Commodities
OIL: Brent: 49.00 (dollars per barrel)
GOLD: 1112 (dollars per ounce)
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Regards
Paul McCormick
