China Economy in focus.
China Economy in focus.The implications of stock market volatility for traders
This has hardly been a tranquil summer in China. June and July saw wild swings on the China stock market – including a 8.5% slump in a single day. This was followed on 11 August by a move on the part of The People’s Bank of China to weaken the nation’s currency – a move that kickstarted the yuan’s steepest two-day drop since 1994. Just over a week later, new measures to shore up the markets failed again – causing a downward trend around the globe. Whatever your trading preferences, it’s almost certainly the case that China features somewhere when considering the fundamentals. With this in mind, we take a look at the wider implications of this recent flurry of activity.
The Chinese currency landscape: a brief tour…
Terms and abbreviations associated with the yuan are sometimes used interchangeably and occasionally incorrectly. For those traders who only come across the Chinese currency in passing, a quick glossary may be welcome – so here goes:
- RMB is the official abbreviation of renminbi, the Chinese currency – and the unit of account is the yuan
- CNY is the currency code for RMB where it is traded in mainland China
- CNH refers to RMB where it is traded offshore
Prior to the creation of CNH in 2010, the RMB market was essentially closed off to offshore parties. What triggered the change of policy was the 2008/09 financial crisis. This was the point where China started to push for the internationalisation of its highly restrictive currency with the goal of it becoming a reserve currency and general means of transaction. Now, CNH is freely traded offshore without restriction so long as the funds do not flow back into China.
In January of this year, Reuters was reporting that the yuan (specifically CNH) was heading for the currency major league, with data showing that offshore trading on Thomson Reuters trading platforms had increased 350% in 2014. Yet (at the time the Reuters article was published at least), the system of strict currency controls in place, principally in the form of measures to keep the yuan artificially high, was identified as still having a significant limiting effect on trading activity.
Fast forward to the present, however, and what we have seen is evidence of China loosening its grip on its FX regime. Notwithstanding recent events, it’s worth pointing out that if the overvalued RMB were to fall back in line with global currencies, this could mean that CNH will start to feature in the list of popular currency pairs for binary options trading (something to earmark for the future, perhaps).
The downward stock market spike and devaluation: why did it happen?
A “stampede” was how at least one trader described the extraordinary wave of activity that took place on the Chinese stock exchange at the end of June and beginning of July. The previous 12 months had seen a massive influx of private investors, which in turn had contributed to Shanghai stocks soaring by 150%. Then the downturn came in earnest: a 30% drop in the space of three weeks, triggering moves by China’s state asset regulator to suspend trading. Almost half of the companies on the market suspended selling.
So was this a sign or consequence of faultlines in the Chinese economy? Not necessarily. It is true that the rate of growth in China is in long-term slowdown mode, having fallen from 14% per annum in 2007 to 7% based on Q2 2015 figures . However, the recent collapse was thought to have been fed more by sheer momentum and a strong element of herd mentality than a fair reflection of the fundamentals – not least because an estimated 80% of investors in China are small retail investors, rather than institutions. A view backed up by the IMF when the impact became global towards the back end of August.
The response from the Chinese authorities came initially in the form of buying large quantities of stock. Next came devaluation. Although the stock market crash was never officially given as a reason for the Yuan’s change in direction, the timing of the action suggests it was at the very least, a contributing factor. The move triggered a decline in value by about 4 percent against the dollar.
By no means did the actions taken by the Chinese amount to open flotation of the yuan: rather, the process followed for fixing the currency has now changed. The Bank stated policy is that it will now fix the yuan to the US Dollar based on USD’s closing level the previous day. The currency can still only trade 2 percent above or below the fixing level.
China in trouble – Consequences for other markets…
Forex
In China, 12 August saw the yuan hit a 4-year low of 6.4510 per US dollar before rallying slightly. In international trade, it touched 6.59 to the dollar.
So far as the most commonly traded currencies were concerned, devaluation triggered a distinct East v West split. Sterling reached a 10-month high. The euro was up slightly – as was the dollar. By contrast, Australia saw its currency slide against its US equivalent by almost a cent. The Yen was also down.
So where to next? The indications are that the medium term could see further devaluation of the yuan. For the Yen and AUD this could mean both currencies will leak support – and for similar reasons. In Japan, government policy is to drive exports and the Chinese export market is now more valuable to the Japanese than the US market. Another yen devaluation may very well be in the mix if the yuan falls further. For Australia, commodities are the driving factor; RMB devaluation places near-irresistible downward pressure on the Aussie to keep iron ore and coal flowing across the South China Sea.
By default, expect further devaluation to bring gains for Sterling, the Euro and Greenback. Keep in mind however, that talk of rises in interest rates in the US or UK have already – to a certain extent – been priced in. Turmoil in China may put interest rate rises back, meaning a weakening in those currencies too.
Commodities
Metals were the big loser – with copper falling 4 percent to a 6-year low. When it becomes more expensive for the world’s biggest consumer of raw materials to import them, a downward spike is inevitable – so expect more of the same in the event of further yuan devaluation. The developments in China were also enough to push the price of Brent crude below the $40-per barrel mark. For gold, however, it’s a case of the safe-haven effect kicking in: it rose to a 3-week high following the yuan shift.
Stocks
If further devaluation is in the air, it’s a case of reviewing your portfolio and getting bearish on the stocks of any companies that are heavily exposed to the Chinese export market. By way of illustration, the likes of Burberry and Jaguar Land Rover took a big hit – as did the big mining groups.
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