Global markets are continuing to face downside pressure and are exposed to further declines after the People’s Bank of China (PBoC) shocked the financial markets for the second morning running by devaluing the Yuan once again. The USDCNY has now sky-rocketed from 6.22 to as high as 6.59 in just over 24 hours, which highlights how huge the concerns are within China over the recent declining exports numbers, and how internally motivated they are to enhance export competitiveness. Everyone knows that the China economy is slowing down and facing significant downside pressures, the economy is vulnerable to falling below the government’s 7% GDP target and both the PBoC and Beijing government will do whatever it takes to defend this benchmark.
What the markets need to realize is that the China economy has been suffering from reduced inflation and declining domestic momentum for quite some time, however the export numbers over the weekend highlighted an emerging risk that there is even slower demand for Chinese products, and that the economy is exposed to weakness outside of mainland China. If this risk intensified and exports continued to decline, this would have likely all but confirmed that GDP growth will fall below the government target of 7% and China will do whatever it takes to ensure this risk is reduced. The economy is going to remain vulnerable and exposed to falling below 7%, which means that the markets need to get used to waking up to further headlines from China, and this will likely include news regarding further currency intervention, interest rate cuts and support to the Shanghai Composite Index.
Why have emerging markets suffered the most? This is not just limited to exports to China becoming more expensive, but also because these economies need to adapt to a new era where they become less reliant on trade with China. The China economy is in a complete transition stage where it is attempting to move away from importing goods and focusing on domestic growth. By devaluing the currency they have not just enhanced export competitiveness, but also improved inflation expectations because a weaker currency is inflationary in itself while also inspiring consumers to look more for domestic products. Emerging markets are now going to suffer from a downturn in exports at the same time that the aggressive selling in commodity markets has resumed, meaning that we can expect further currency weakness throughout the second half of the year.
Gold has benefited the most from the situation in China because the metal looks set continue building on the strongest rally seen in months. Gold has jumped close to $30 over the past two days and its ability to move after the devaluation of the Yuan will erase those concerns that Gold has lost its appeal as a safe-haven. Everyone will now be awaiting for any clues from the Federal Reserve on how this move might impact their attentions to begin raising US interest rates and if it does, there is inspiration for the Gold bulls to continue recovering what have been stunning losses over the previous couple of months.
I personally do not believe that this move from China should impact the Federal Reserve in regards to when it begins raising US interest rates. The US economic data is consistently robust and raising optimism that the economic recovery is sustainable. This is enough of a reason to inspire the Federal Reserve to carry through with their repeated pledge to begin raising US interest rates in 2015. However, a previous FOMC statement did highlight that the central bank were monitoring international risks and with the recent developments in China and resumed selling in commodities widening the woes for the emerging markets, these international risks are growing.
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