China’s devaluation in context

China is at the center of the recent financial market volatility, which has caused the VIX index to double over the past week. The turmoil reflects a complicated mix of concerns over macro and market fundamentals, exacerbated by the recent exchange rate adjustment.

Even though the Chinese devaluation last week was very small in absolute (approximately 3%) as well as in relative (compared to other EMs or even DM currencies like the EUR) terms, it has caused a lot of speculation. We remain convinced that the main reason for the devaluation is a first step in a very long process towards a free floating currency. This is a positive development, welcomed by the IMF, even though it causes volatility in the short term. We do not think that export competitiveness was an important factor behind the decision, even though the timing of the decision and recent economic data have led some analysts to believe that could be the main reason. And at least some of the current sell-off in financial assets around the world is related to concerns about the health of the Chinese economy.

Most equity markets sold off sharply on Monday but emerging market assets, especially those related to commodities, have been among the hardest hit and several countries have devalued their currencies over the past week. We believe assets may correct even more as there are few obvious positive triggers in the short term and markets tend to overshoot. A number of commodity dependent currencies with fixed pegs look particularly vulnerable. We do not, however, think the RMB will move much more in the short term. The band is likely to widen gradually over time but the next step may take time given the volatility caused by these first moves.

In the meantime, the focus will return to the anticipated FED hike. The recent volatility has reduced the expectations of a September lift-off. A delay of the hike would support sentiment and EM assets in the very short term, but we think that US interest rates will stay exceptionally low in any case and therefore believe that it is better to get the first hike out of the way. EM assets have already corrected massively and the lift-off could, somewhat counter-intuitively, mark the beginning of the end for the negative EM sentiment.


Marcus Svedberg is chief economist at East Capital

Jonathan Boyd
Editorial Director of Open Door Media Publishing Ltd, and Editor of InvestmentEurope. Jonathan has over two decades of media experience in Japan, Australia, Canada and the UK. Over the past 17 years he has been based in London writing about funds and investments. From editing the newsletter of the Swedish Chamber of Commerce in Japan in the 1990s he now focuses on Nordic markets for InvestmentEurope. Jonathan was awarded Editor of the Year at the Professional Publishers Association (PPA) Independent Publisher Awards 2017. Shortlisted for the same in 2016, he was also shortlisted in 2017 and 2015 for the broader PPA Awards category Editor of the Year (Business Media).

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