Already beaten up, emerging markets stocks and exchange traded funds were punished Tuesday after the People’s Bank of China decided to devalue the yuan. The sudden shift in its currency policy suggests that Chinese officials are seeking a way to stimulate growth after a series of monetary and fiscal policies failed to significantly bolster the economy.
Additionally, the PBoC’s move may also signal a start to the country’s move toward reforms – many have criticized China’s currency policy, arguing that the central bank has artificially strengthened the yuan. Consequently, with the devaluation, the yuan may be more closely aligned with market actions. [Violent Turn for the Yuan]
The subsequent spike in volatility caused by China’s newly loose monetary policy is elevating the cost of protective bearish hedges on marquee emerging markets indexes.
“The Chicago Board Options Exchange Emerging Markets ETF Volatility Index, which tracks hedging costs on the iShares MSCI Emerging Markets fund, jumped to the highest level in 18 months versus a similar gauge for the Standard & Poor’s 500 Index,” report Callie Bost and Aleksandra Gjorgievska for Bloomberg.
The MSCI Emerging Markets Index is the underlying benchmark for the iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the second-largest emerging markets ETF by assets. The Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), which tracks a FTSE index, is the largest emerging markets ETF.
EEM is down nearly 10% this year. China is the ETF’s largest country allocation at 24.2%, or more than 1,000 basis points more than the fund allocates to South Korea.
China’s currency devaluation is aimed at propping up exporters in the world’s second-largest economy amid slack economic data. Beijing revealed that exports declined 8.3% in July, the largest drop in four months and worse than the expected 1% dip. Exports to the Eurozone plunged 12.3% in July and shipments to the U.S. fell 1.3%.
“The yuan devaluation may signal that China’s efforts to rebalance its economy toward greater growth may be proving more challenging than anticipated. According to some estimates, the trade-weighted yuan has increased by over 11% in the past year, and exports have been falling sharply — down 9.2% in July. A weaker yuan may help turn growth around by boosting China’s exports, but a roughly 2% currency devaluation is only a small step toward that goal,” said Invesco in a recent research note.
iShares MSCI Emerging Markets ETF
Tom Lydon’s clients own shares of EEM.