China devalues the renminbi. What’s next?
August 12, 2015
The People’s Bank of China (PBoC) lifted the fixing rate for the U.S. dollar to the Chinese renminbi by roughly 1.9%, effectively weakening the renminbi. The PBoC has promised this is a one-off move, though we are highly skeptical that this will be the case. As we have writtenwrittenwritten previously, we believe this could signal a new phase of a global currency war. Suffice it to say that Asian currencies are broadly weaker alongside the renminbi and the U.S. dollar is nearly universally stronger on the day.
Though we are likely to hear from the financial press that this is a positive for global growth and has more to do with the renminbi’s potential inclusion in special drawing rights* (SDR) than a currency war, we think this might not be the whole story. China appears to be economically drowning and, in our opinion, is now grabbing onto the nearest piece of floating debris as the ship continues to founder. We believe the debris in this case is currency devaluation:
- While we believe SDR inclusion is important to China, we believe the PBoC is using this backdrop to “liberalize” (read: weaken) the renminbi in the face of an economic slowdown — essentially using SDR inclusion as air cover to weaken the renminbi. (Curiously, this happened after China printed an 8% year-over-year decline in exports.)
- This is an indication of how bad the Chinese economy is actually performing. This was the last lever the PBoC could pull, and it just pulled it. We believe the PBoC will do so again as necessary. With growth falling, exports falling, the consumer price index falling, and the producer price index highly negative, we believe this is perhaps more of an economic “tell” than the press is reporting.
- The renminbi’s weakness may release another deflationary wavedeflationary wavedeflationary wave on the globe. The PBoC is attempting to import some inflation and increase exports. But to whom are they going to export? Asian currencies have weakened along with the renminbi. We believe this creates more deflationary issues for the United States and Europe (see chart below).
Asian currencies slide
One-day percentage change across a range of currencies (versus the U.S. dollar)
Data: Bloomberg, as of Aug. 11, 2015.
What happens next?
- I would suspect we see more aggressive moves out of Asia in order to compete. Taiwan and South Korea are likely candidates to continue attempting to weaken their currencies, the Taiwanese dollar and the won, respectively, given inflation and export trends. In other words, we don’t believe the PBoC’s move is the last action we see within China or across the region.
- After today’s knee-jerk reaction of dollar strength, we may see markets gravitate toward a more sanguine view of the Chinese move regarding global risk sentiment. The rationale may be that the Chinese economy will start to export more with a weaker renminbi and thus China will demand more commodities to create exports. We don’t believe this will happen. We view this instead as an opportunity to sell into this initial near-term strength in risk-sensitive commodity currencies.
- Today’s activity may force the Federal Reserve to re-evaluate the conditions for a September rate hike in light of the potential deflationary wave this is likely to release on the globe. We believe the Fed can’t risk it now, or that at the very least it will be given a new moment of pause on the decision in September.
Read previous comments from our investment teams on China and currencies:
*Special drawing rights are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). Their value is based on a basket of key international currencies reviewed by IMF every five years.
The views expressed represent the Manager's assessment of the market environment as of August 2015, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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The Consumer Price Index, or CPI, measures changes in the general level of goods and services that are consumed by Indian households. As measured here, headline inflation is the pure, raw measurement of inflation; it does not account for seasonal factors, and it omits price changes in the broad food and energy categories.