Just one day after surprising markets by devaluing its yuan, the People’s Bank of China (PBOC) moved to weaken the currency again on Wednesday. These actions are the latest in a string of policy interventions designed to stabilize markets, support economic growth and manage China’s longer-term transition from an investment-led to a more consumer-driven economy.
While the overall size of this move is not massive, it does raise ripple effect questions that need to be considered. Both the timing and the implications of the currency adjustment create uncertainties about the state of emerging markets and what impact this has across other asset classes. The devaluation also raises a question about the timing of the Federal Reserve’s first interest rate hike in nearly a decade, which was largely anticipated by the market to be on track for September.
Here is what investors need to know about the current situation:
What happened?
On Tuesday, China’s central bank moved to devalue the yuan, cutting its daily reference rate by 1.9% vs. the US dollar. This triggered the biggest one-day drop in the yuan since January 1994. The PBOC also announced that future fixing will be based on supply and demand.
On Wednesday, the bank showed its commitment to the new policy of weakening the yuan by cutting its daily reference rate by another 1.6% as market forces showed further weakness in the yuan.
The devaluation heard around the world
Reaction to the devaluation reverberated across global financial markets with other regional currencies—including those in South Korea, Australia and Singapore—dropping 2% or more. Commodities declined amid implications about China’s growth and the impact a weaker yuan will have on imports by the world’s biggest consumer of raw materials.
Equity markets initially fell and worries about the increase in cost of consumer goods for Chinese buyers weighed on stocks with significant exports to China. Investor sentiment took a decidedly “risk-off” tone, and US Treasuries gained as both a safe haven asset and on fears of continued global economic malaise. German two-year bund yields fell to a record low on Wednesday morning.
Ripple effects for emerging markets and the Fed