Global equity markets were mixed last week, with the major indices in Europe sharply lower following the surprise move by the People’s Bank of China (PBOC), China’s central bank, to devalue their currency. Starting Tuesday, over the next three days the PBOC lowered the value of the country’s currency by around 4% against the US dollar, the largest weekly decline on record.
In truth, the PBOC move shouldn’t have come as such a huge surprise given the slowdown in the Chinese economy and with other central banks actively pursuing weaker currencies to help boost exports. I wrote on this subject back in March in my blog post “beggar-my-neighbour policies”, a world where countries compete for lower global growth through competitive devaluation.
However, the PBOC is doing its best to reassure its trading partners that this is not part of a sustained devaluation, but rather part of their efforts to allow market forces play a bigger role in setting the exchange rate. This is seen as a prerequisite for joining the IMF’s Special Drawing Rights, an international reserve asset created by the IMF currently based on four currencies – Euro, Yen, GBP and USD. Still, a further devaluation seems likely, something which will have its closest neighbours on edge!
Positive US economic reports released last week on inflation, retail sales, employment and industrial output will all support the case for the US Federal Reserve lifting interest rates for the first time in ten years at their meeting in September. Still, there is a suggestion that the increased volatility emanating from China could cause the Fed to delay their decision to raise interest rates. It remains a flick of a coin on whether the Fed will move in September, but there is no doubt they will ere on the side of waiting if we were to see a renewed bout of volatility in US equity markets.
Sell-off in European equity markets…..
In Europe, the FTSE Eurofirst 300 closed down -2.94% for the week. The German DAX index was one of the worst performers, down -4.40%, as concern rose that exporters will be hurt by a weaker Chinese currency through lower demand from the Chinese. In the US, the major indices were relatively unfazed by the PBOC decision, closing marginally higher over the week; the S&P 500 closed up 0.67%. In Asia, Japan’s Nikkei 225 index fell -0.99%, while China’s Shanghai Composite Index of mainland shares bucked the trend, rising 5.91%.
German 2-year government bond yield hit a record low…..
The midweek sell-off in European equity markets pushed up demand for perceived ‘safe-haven’ assets. The German 2-Year government bond yield hit a record low of -0.29% on Wednesday, a reminder that even at negative yields these bonds can act as a diversifier within investment portfolios when turmoil hits the financial markets. Still, it is galling for investors to have to pay governments to hold their money, in this case the AAA rated Germans.
Euro higher as risk aversion sets in…..
On the currency front the Euro moved higher as risk aversion set in, a by-product of its funding currency status, rising 1.55% against the US dollar to $1.111. Record low interest rates in Europe drives the appeal of the Euro as a funding currency, meaning traders borrow in Euro to invest in higher yielding risk assets. However, as traders shift to a “risk-off” mind-set, the unwinding of these trades requires the buyback of Euros, providing the impetus for the single currency to move higher.
European equity markets have opened higher following a mixed session in Asia overnight, The Japanese economy contracted -0.4% in the second quarter, from the previous quarter, adding to concern about the loss of momentum behind the global economic recovery.
Key macro data for the week ahead includes flash PMI surveys from the Eurozone and China, a useful leading indicator of what we can expect from these economies in the third quarter. The raft of housing reports throughout the week will provide an update on the US housing market. There is inflation data from the UK and the US. Also due out from the UK is the latest report on retail sales. On Wednesday, the US Federal Reserve will release the minutes from their most recent monetary policy meeting, providing further insight into the views of the committee members as the first rate hike draws closer.