China devalues the yuan and Western markets fall

The People’s Bank of China (PBOC) announced that it was decreasing the country’s currency value by 1.9% to a three year low on Tuesday, after economic data over the weekend showed that year-over-year exports fell in China during July by 8.3%.

China’s central bank controls the so-called midpoint of the yuan’s exchange rate versus the U.S. dollar, and allows daily market trade to raise or lower that rate by a maximum of 2%.

Previously, PBOC had set the exchange rate at 6.1162 yuan per dollar, but Tuesday morning’s devaluation adjusted that number down to 6.2298. By the end of the trading day in Shanghai however, spot yuan finished even lower to 6.3321 yuan/dollar.

By lowering the value of their currency, Chinese economic planners hope to increase exports by making their home-made products cheaper in foreign countries. Doing so, however, comes at the cost of higher domestic prices for imported goods.

“What the world needs from China is not more supply,” said Patrick Chovanec of Silvercrest Asset Management. “What it needs is demand.”

Indeed, U.S. and European markets declined Tuesday. All three major U.S. stock indexes fell by around 1%; The German DAX lost 2.68% of its value; UK’s FTSE 100 index finished the day -1.06%.

In the U.S., stocks which rely heavily on the Chinese domestic market took the brunt of the hit, as Apple shares tumbled by 5.15%, while Caterpillar’s lost 2.64%.

Commodity prices also fell as the Bloomberg Commodity Index, which tracks 22 commodity futures across seven sectors, was -1.62%.

Specifically, Crude Oil futures set for September delivery hit a six-year low of $43.08 per barrel, and has lost 3.8% in the past 24 hours.

Most agriculture futures also retreated as Wheat and Corn both fell more than 3% respectively, by the end of the trading day.

The Dollar Futures Index (DXY) rose slightly from below $97 on Tuesday morning, to $97.20 at the time of publication.

“I think the market’s perception is if China is doing (devaluation of its currency), they’re really worried about their economy,” said Jason Leinward, managing director at Riverside Risk Advisers. “Any currencies that have direct ties with China will be weakened.”

PBOC’s weakening move also comes at a time when China’s leaders are trying to make a serious case that the yuan be included in the International Monetary Fund’s (IMF) Special Drawing Rights basket of currencies – “an international reserve asset”. For the yuan to qualify for reserve status, the Chinese must demonstrate its currency is ‘free-floating’, subject to the markets and not artificial manipulation.

Whether IMF buys into China’s latest move (and rhetoric), is another question. A decision is due by the end of the year. Until then, market watchers will be keeping a close eye on China’s currency to see how ‘free’ the central bank allows the yuan to be.

We’ll certainly be able to feel the effects of any further manipulation here in the Western hemisphere, through the stock, bond, and commodity markets.

 

[Reuters] [CNBC] [Bloomberg] [Photo Credit: Andy Wong/AP]