China Devalues Yuan

On Tuesday of this week, China began systematically lowering the value of the Yuan in relation to the U.S. Dollar. The devaluation of the Yuan has continued this week, with the People's Bank of China raising the targeted fix to the Dollar on each successive day, weakening the official Yuan target by 1.9% on Tuesday, 1.6% on Wednesday and 1.1% on Thursday.

Making the Yuan cheaper appears to be a direct response to the economic problems currently facing China, which we have blogged about previously. On Wednesday, China also released a host of economic data points - with indicators such as retail sales, industrial production, and fixed investment all coming in below forecast. The compounding concerns over their domestic economic conditions likely led China to fall back on an old stalwart for growth - cheap exports.

That does not mean that China is looking to pull the floor out from under the Yuan, and allow it to free fall. A freefall would undermine a goal China has been steadily moving toward - inclusion of the Yuan in the IMF's Special Drawing Rights basket of currencies. As a result, China is still looking to maintain an orderly devaluation - reports indicate that the PBOC instructed banks to sell Dollars during the last 15 minutes of trading on Wednesday, erasing some of the Yuan's decline, which had overshot the established target for the day. While PBOC representatives have stated that there is "no basis for persistent and substantial devaluation", many market pundits expect further declines this year.

Other analysts have pointed out that the devaluation of the Yuan could also be seen as a response to the rising value of the Dollar, which has gained close to 13% since this time last year. While it ended the official peg to the Dollar in 2005, China has still maintained a loose peg to the Dollar ever since, and following the Dollar's upward climb has made its currency expensive compared to other export focused peers (like Japan, Germany, etc). This devaluation could be an attempt to stay competitive.

Stocks of export focused companies in both the U.S. and Europe were hit hard by the devaluation, though prices have begun to stabilize. The devaluation has also given doves on the Federal Reserve Board ammunition to use against more hawkish members. The slowdown that the devaluation is a symptom of, and the devaluation of other currencies it is likely to provoke, suggests a rough season for exports, and a slackening of inflationary pressure globally. This is the type of news that anyone arguing against a September rate raise would be happy to receive. What the Fed will actually do remains to be seen, and will likely depend on what else China does in the next month, as well as the direction and trend of global and domestic economic indicators.