This morning’s Chinese record currency devaluation, in which the Yuan was devalued by 1.9% against the USD may sound like a lot… until one considers that the Chinese currency has been pegged to the US dollar, which as reported extensively over the past year, has exploded higher not so much due to the strength of the US economy but due to expectations of what may be the Fed’s biggest mistake in recent years: a rate hike which will assure the US economy’s tailspin into recession.
In effect what the PBOC did earlier today is inform the world it would no longer stay pegged to a Fed whose monetary intentions are complete lunacy for a mercantilist exporter, one whose economy is getting crushed as a result of the tight linkage between the USD and CNY, and even if it means massive capital flight as the opportunity cost, so be it. Furthermore, considering that the CNY was until recently the second most expensive currency according to Barclays, it is amazing it took Beijing this long to pull the plug.
So how much more devaluation is in store for the CNY? Well, if one believes the PBOC, today’s intervention was a “one off.” The problem is that just like every central bank in modern history, the Chinese central bank is lying.
Here is Goldman with a quick and dirty observation of what one can expect:
According to the PBOC press release, the unexpected change in fixing mechanism today was in response to the prospective Fed liftoff, which has the potential to cause further strengthening in the USD and capital flow volatility. The CNY on a trade weighted basis has appreciated sharply alongside the USD strength, and is still about 15% higher than a year ago after today’s move (Exhibit 1). However, we think a FX move of today’s scale, while significant by the standard of CNY’s historical movement, is unlikely to give a strong boost to growth.
In other words, today’s “devaluation” is a tiny pinprick in the grand scheme of the CNY’s revaluation since the USD surge started in 2014. This becomes especially apparent when one sees the impact of the CNY’s peg to the soaring USD, and last night’s shocking announcement, in context.
So to answer how much more downside in the CNY there is, now that the PBOC has thrown in the towel and will aggressively devalue the currency, the answer is somewhere between 10 and 15% more if China wishes to regain its competitive status as of just last summer!
Which means an unmitigated disaster for US, European and Asian, exporters whose only lifeline was China’s FX patience.
Patience, which just ran out.
And for all those wondering why stocks are red today, the answer is simple: in a zero-sum trade world, the market now demands much more QE from the ECB, BOJ and, soon enough, the Fed itself because the deflationary export deluge which China just unleashed will send the 10Y solidly below 2% in the coming days unless some “western” central bank somewhere does or says something to remind the market who is in charge..
