The Yuan’s Falling, and the Market’s Not Panicking

The Yuan’s Falling, and the Market’s Not Panicking

The steep drop in the value in U.S. dollar terms of the Chinese yuan contributed a lot to the difficulties experienced by the U.S. stock market in 2015 and 2016. The yuan’s initial sharp devaluation in early August, 2015 caused the S&P 500 to correct by 11%. Between that initial devaluation and the U.S. presidential election in November, 2016, the yuan fell almost 9%; the U.S. stock market traded sideways with significant volatility and only moved to significant new highs again after the election was over.  In short, Chinese currency instability was not friendly to U.S. stock market performance, and caused U.S. investors a lot of anxiety.

Chinese Yuan and U.S. Stock Market Volatility, 2015–2016

Source: Bloomberg Finance LLP

Fast-forward to 2018, and something not too dissimilar is going on with the Chinese yuan. Since April 2018, the yuan has fallen more than 8% against the dollar, much more precipitously than during the long decline of 2015–2016.

Yet, there’s been no comparable reaction from other markets. Indeed, during this year’s yuan slide, the U.S. stock market has been rising steadily. So what’s different this time? We borrow the following points from Jonathan Anderson of Emerging Advisors Group, our favorite China analyst.

First, the macro backdrop is different. In late 2014 and 2015, the Chinese economy had sharply decelerated. Big industrials and state-owned enterprises’ profits were actually contracting. Jittery local and global markets were already thinking that this could be “the big one,” a “hard Chinese landing” with all the bad knock-on effects it would have on the global economy. The economic situation in China is very different today — Anderson says, “This is an economy that appears to be [in] relatively good health.”

Second, after the 2015–2016 slide, the yuan ended up appreciating. This time, markets are not so quick to assume that catastrophe is imminent.

Third, the current correction has been short and sharp, and with no fear underneath whispering that there’s more to come, markets may believe that the Chinese central bank is done for now.

Fourth, there are many more capital controls in place than there were during 2015–2016, so the effects of the decline are more muted and likely causing less fear globally.

And fifth, there are anecdotal reports that the People’s Bank of China (PBoC) is intervening in overseas yuan markets to “make sure that pricing there remains well-behaved.”

In short, there’s a lot in place now, from the economic backdrop to Chinese regulatory changes to PBoC actions, to calm markets.

Investment implications: Although the Chinese economy is reasonably strong, it has been weakening. For a variety of reasons, it may continue to weaken, particularly under the pressure of rising trade conflict with the United States and other developed nations. Should wide-ranging tariffs take hold and no deal be forthcoming, the government may resort to continued devaluations as a counter-measure. All of this urges vigilance in terms of yuan valuation relative to the dollar and to the currencies of China’s other trading partners — even though global markets have not been perturbed by the yuan’s recent slide.