Investors around the world were taken by surprise on Tuesday after the People’s Bank of China (PBoC) devalued the yuan by almost 2 percent against the U.S. dollar, causing the currency to suffer its biggest fall in over two decades.
The move sent shockwaves through markets, as currencies with heavy trade exposure to China hit lows against the U.S. dollar and equities on both sides of the Atlantic tanked. Commodities were hit hardest, as oil and industrial metals faced severe selling.
Brent crude tumbled $1.29 to trade at $49.11, erasing most of the gains made in oil’s biggest daily rally since late May the previous session,while U.S. crude plunged 3.6 percent to $43.31. Three-month nickel and copper both slumped in the region of 3 percent on the London Metal Exchange.
U.S. stocks opened sharply lower on Tuesday after the surprising move overnight, with the Dow Jones industrial average falling more than 150 points in the open. The index snapped a seven-day losing streak on Monday with a 241-point gain.
U.S. sovereign bond yields also took a sharp tumble after investors rushed in to buy safe-haven Treasurys after the central bank’s surprising move. The yield on the benchmark 10-year Treasury note fell around 7 basis points on Tuesday to trade at 2.165 after closing at 2.238 percent.
Meanwhile, gold was one of the few beneficiaries of the move, with the precious metal hitting a three-week high of $1,119, gaining more than one percent in early trade, before paring gains to trade flat.
The central bank cut the renminbi’s daily peg against the U.S. dollar to 6.2298 renminbi, down from 6.1162 on Monday, describing the unexpected move as a “one-off depreciation”. But market watchers have widely interpreted it as the first of many moves to help restore competitiveness in the Chinese economy by weakening the currency.
The move has also prompted fresh talk of global “currency wars” additional monetary easing elsewhere, and even speculation that the U.S. Federal Reserve will be slower to raise interest rates, chief global economist as Capital Economics, Julian Jessop said.
“Some have concluded that this means that the PBoC will have to let the renminbi fall a lot further and that today’s move is simply the first of many steps in that direction. However, we think it makes more sense to focus on the official explanation that this is a one-off adjustment to how the reference rate is set as part of an ongoing program of market reforms. The acid test of this will come in the coming days,” Jessop said in a note to clients.
“If we are right, then talk of this triggering a fresh wave of global “currency wars” is clearly overdone. Most currencies have still fallen substantially further against the US dollar. The idea that some additional, relatively limited moves in the renminbi-dollar rate will have a material impact on the economies of Europe or the US, let alone the rate decisions of the Fed, is frankly ludicrous,” he added.
Currencies among the most severely hit were the Australian and New Zealand dollars which tumbled 1.3 percent and 1 percent against the greenback respectively. Japan’s Yen also fell to a two-month low.
“The next couple of days will be watched closely. We believe PBoC will let the fix adjust further to market forces, albeit more gradually. Meanwhile, the central bank could also smooth the upside in onshore dollar-yuan (USD-CNY) spot to prevent it from overshooting and ensure market order. Eventually, USD-CNY should gradually settle at a new equilibrium level,” head of global emerging markets FX research at HSBC, Paul Mackel said.
In Europe, stocks extended losses throughout the trading session, with the German DAX facing the brunt of the selling, falling 2 percent after the country’s ZEW survey showed economic sentiment weakened from the previous month. The pan-European FTSEurofirst 300 traded around 1.5 percent lower.
“Some commentators have observed that if the market is allowed to determine the level of the Chinese currency, its recent behavior suggests it will try and push it lower. That may not be to the liking of the PBoC, who can intervene to push back,” co-head of multi-asset at Henderson Global Investors, Bill McQuaker said.
However, if they were to fight the market and support the currency, why loosen the reins in the first place? Make no mistake, the days and weeks ahead will be interesting ones to watch, and may have real impact on asset prices,” he said.