Why You Should Care About China’s Currency

By Bryan Rich 

January 5, 2017, 4:00pm EST

We talked yesterday about the bad start for global markets in 2016.  It was led by China.  Today, it was a move in the Chinese currency that slowed the momentum in markets.  Yields have fallen back.  The dollar slid. And stocks took a breather.

China’s currency is a big deal to everyone.  It’s the centerpiece of the tariff threats that have been levied from the U.S. President-elect.  I’ve talked quite a bit about that posturing (you can see it again here:  Why Trump’s Tough Talk On China May Work).

As we know, China, itself, sets the value of its currency every day.  It’s called a managed float.  They determine the value.  And for the past two years, they’ve been walking it lower – weakening the yuan against the dollar.  That’s an about face to the trend of the prior nine years.  In 2005, in agreement with their major trading partners (primarily the U.S.), they began slowly appreciating their currency, in an effort to allay trade tensions, and threats of trade sanctions (tariffs).

So what happened today?  The Chinese revalued its currency — pegged ithigher by a little more than a percent against the dollar.  That doesn’t sound like a lot, but as you can see in the chart, it’s a big move, relative to the average daily volatility. That became big news and stoked a little bit of concern in markets, mostly because China was the sore spot at the open of last year, and the PBOC made a similar move around this time, when global marketswere spiraling.

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Why did they do it?  This time around, the Chinese have complained about the threat of capital flowing out of the country – it’s a huge threat to their economy in its current form.  That’s where they’ve laid the blame, on the two year slide in the value of the yuan. With that, they’ve allegedly been fighting to keep the yuan stable and have been stepping up restrictions on money leaving the country.  Today’s move, which included a spike in the overnight yuan borrowing rate, was a way to crush speculators that have been betting against the currency, putting further downward pressure on the currency. But it also likely Trump related – the beginning of a crawl higher in the currency as we head toward the inauguration of the new President Trump.  It’s very typical for those under the gun for currency manipulation to make concessions before they meet with trade partners.

So, should we be concerned about the move today in China?  No.  It’s not another January 2016 moment. But the move did drive profit taking in twobig trends of the past two months:  the dollar and U.S. Treasuries.  With that, the first jobs report of the year comes tomorrow. It should provide more evidence that the Fed will hike a few times this year.  And that should restore the climb in the dollar and in rates.

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