- What appears a second devaluation confuses the market
- USDCNY will eventually drop around 10%
- USD, GBP and the less liquid currencies are suffering most
- US September rate hike suddenly looks a very low odds proposition
- AUD has traded the weakest on the CNY devaluation
By John J Hardy
Please have a look at the piece I wrote yesterday on China’s move to devalue the renminbi – Did China just float the yuan? Observers are calling the latest weakening overnight in the yuan a “second devaluation” as China set the fix at a significant gap relative to the previous day’s closing level.
In theory, the Peoples' Bank of China is merely setting the price where it assesses supply and demand are pushing it – but de facto, the gap looks and sounds like a second devaluation and confuses the market after yesterday’s move was touted as a “one-time” move, with subsequent action to be driven by supply and demand.
It’s a communication failure in any case and the market does not like what it sees. Yesterday, perhaps the belief was that the rate would be set near the previous day’s close and then “the market” would be allowed to push it slowly weaker in an orderly move over the next few months.
Instead, a second large gap in two days means the market has a hard time assessing how far and how quickly this devaluation will take place. Will the PBoC stop in a week after a 5% devaluation or is the intention to drive it 20% weaker?
I suspect the move will stop as quickly as it began at some unknowable point in the very near future (perhaps 6.80 area in USDCNY
where the rate was fixed during the global financial crisis and representing approximately a 10% move?) and then the PBoC will try to make things as boring as possible.
The initial reaction to the Chinese devaluation has been extraordinarily different from every major episode of devaluation thus far, from the US Federal Reserve’s iterations of quantitative easing, to the Bank of Japan’s huge QQE move, and finally the European Central Bank’s move earlier this year.
The market is struggling to take in how far Beijing wants the yuan to drop. Source: iStock
In all of those instances, the market celebrated the liquidity implications of all the money printing and piled into risky assets. This time, the first reaction is one of uncertainty and the worry that China is exporting new deflationary pressures. But if we close the circle of the market’s logic – won’t this eventually mean even more money printing in the rest of the world? That may be the eventual hope that stabilises risk appetite, but that is clearly looking to far ahead at the moment.
So in the risk off department, the US dollar, sterling and the less liquid currencies suffer the most. The USD and GBP are weaker on the idea that any rate hike prospects have been derailed until further notice by China’s move. US 2-year rates, just a couple of days ago near the highs for the cycle, are now near 1-month lows and a September rate hike is looking suddenly like a very low odds proposition.
Risk sentiment is the key driver here for EURUSD, but USDJPY has escaped downside on the idea that CNY devaluation is negative for all currencies. But “normally” one would expect that collapsing Fed expectations and risk-off sentiment would provide significant downside pressure. In any case, let’s watch this 125.00 area and the first tactical support in the 124.50 area.
USDJPY has escaped downside
The G-10 rundown
USD: Has trade defensively on the view that Chinese devaluation impacts the policy calculus for the Fed.
EUR: The chief benefactor here, mostly on position squaring amid all of the uncertainty. Eventually, this is too much, but may not reverse until we see risk appetite coming back recovering.
JPY: It would seem at some point that the JPY’s tendency to rally in risk-off conditions and the fact that the US rate outlook is collapsing would offer support for the JPY – so watching for the risk of bearish reversals in USDJPY here.
GBP: Today’s UK data a test of whether data matters in this environment. UK rate expectations are also collapsing, so if we continue to trade risk off, the risk to GBP is to the downside.
CHF: Interesting that the franc continued to spike weaker despite all the risk-off fuss over the CNY devaluation. Suggests the franc is on very weak footing and could remain that way.
AUD: Has traded the weakest on the CNY devaluation, but interesting to see where we close the day today as AUDUSD interacts with the low for the cycle near 0.7250.
CAD: One question for commodities is whether Chinese devaluation completely outweighs the weaker USD - for now the answer is yes in oil, which is a CAD negative, but USDCAD not sure what to do in the 1.30-1.32 range.
NZD: NZDUSD weakened below 0.6500 on the weight of the further CNY move, but let’s see whether market can sustain momentum and where we close the day.
SEK: EURSEK trading in a stable range near 9.60 – looks like a resilient performance from SEK, perhaps from a valuation perspective.
NOK: Weak oil prices sees EURNOK taking out all local resistance and trading at the highest since January – risk remains for weaker NOK as long as risk sentiment is weak and oil prices are falling.
Economic data highlights:
- Australia Aug. Westpac Consumer Confidence out at 99.5 vs. 92.2 in Jul.
- Australia Q2 Wage Price Index out at +2.3% YoY as expected.
- China Jul. Retail Sales out at +10.5% YoY vs. +10.6% expected and +10.6% in Jun.
- China Jul. Industrial Production out at 6.0% YoY vs. +6.6% expected and +6.8% in Jun.
Upcoming economic calendar highlights (all times GMT):
- UK Jul. Jobless Claims Change (0830)
- UK Jun. Average Weekly Earnings (0830)
- UK Jun. Unemployment Rate/Change (0830)
- Eurozone Jun. Industrial Production (0900)
- Australia RBA’s Lowe to Speak (1010)
- US Fed’s Williams to Speak (1230)
- Canada Jul. Teranet/National Bank Home Price Index (1230)
- New Zealand Jul. BusinessNZ Manufacturing PMI (2230)
- UK Jul. RICS House Price Balance (2301)
– Edited by Oliver Morrison