Yuan devaluation shocks investors, but G10 currencies take the news in their stride
17/Aug/2015 • Currency Updates•
Typically desultory August trading was abruptly shaken last week by news that Chinese authorities had weakened the Yuan rate against the Dollar by nearly 2%, the biggest such move in over ten years. Further devaluation followed the next day, until the Yuan ended the week down almost 3% against the US Dollar.
This was major news. However, the volatility did not extend to other G10 currencies, where we saw another week of lacklustre trading; typical of August where understaffed trading desks are unwilling to place large bets and there is relatively little news to move markets. We think that the calm reaction in markets is quite justified.
The move by the Chinese authorities was well justified in view of the relentless appreciation the Yuan has experienced against the currencies of China’s major trade competitors; the Yuan has followed the US Dollar higher over the past year. In fact, the present devaluation only reverses about 25% of CNY’s appreciation in the past year alone.
Special mention also goes to the Swedish Kroner, which soared by 2% against most of its peers, on the back of a significant upward surprise in the July inflation report.
Most of the attention last week was centred on the jobs report out of the UK. The news there was mixed.
Unemployment remained unchanged at 5.6% over the past three months. However, June’s rate was at 5.5%, 5.46% to be exact, and pay growth remained relatively high at 2.8%. Wage rises are a full 2% above core inflation, which we think may signal to the MPC that the economy is not far from full employment.
We think that a continuation of pay rises above the 2.5% level will be enough to warrant a first interest rate hike in February of 2016, even in the absence of significant further drops in the unemployment rate.
We had another slew of disappointing macroeconomic news out of the Eurozone last week.
GDP growth printed at a measly 1.25% rate, annualized, in the second quarter. The inability of the Eurozone to maintain even a 2% growth rate for more than a single quarter is especially disappointing given the perfect storm of positive developments in the European economy in recent months. A sharp currency devaluation, much lower oil prices, and an aggressive QE program that has lowered interest rates across the Eurozone, are uniquely positive developments, and yet growth remains stuck, and the tentative improvement in employment we had seen over the last year seems to be petering out.
The ECB’s forecast for a return to growth and a pick-up in inflation look overoptimistic to us; the Yuan devaluation certainly doesn’t help. We expect the common currency to resume its steady downward trend, as the only remaining source of stimulus for the European economy, over the next year.
Retail sales had been a weak spot recently amid generally strong US economic data.
Last week’s release went a long way to assuage those concerns. July sales rose 0.6% on the month, and there was a significant 0.5% positive revision to the prior two month’s numbers. This nice surprise, coupled with the strong numbers we have seen recently on automobile sales and the housing market, mean that the first estimate of second quarter growth (2.3%) is far more likely to be revised up than down.
We expect the steady drumbeat of positive numbers to outweigh worries about excessive Dollar appreciation in the minds of the FOMC, and are therefore keeping unchanged our expectation for a September interest rate hike in spite of last week’s devaluation of the Yuan.