No summer break as Chinese sell-off spooks markets
August is traditionally a quiet month for investors – holidays beckon, the lure of the beach, activities to keep the children busy, searching for sunshine. Dark clouds on the horizon though – is that a storm approaching?
When investment committees return in September, I suggest currency volatility should be on the agenda. The Chinese decision to break the RMB/ dollar peg startled markets. The initial reaction was worry about a currency war amidst fears over the extent of the weakness in the Chinese economy. We saw different reasons for the policy change, namely with the US likely to raise rates in coming months the Chinese wanted to break the peg with the dollar and hence US monetary policy. A more variable currency is also desirable in terms of helping the RMB enter the IMF’s SDR basket in the coming year. A 3-4% move on the RMB is too small to have more than a minor effect on either Chinese trade and inflation or growth and profits prospects in other countries. Nevertheless, the extent of the market reaction shows the sensitivity of investors to any significant changes in Chinese policy making, such as altering the long-standing link with the US dollar.
How does this affect other countries? August’s Bank of England Inflation Report contains a veiled warning - “the continued rise in sterling, which is now 20% higher than its trough in March 2013, is likely to affect the outlook for UK exports and the price of imported goods”. In the US, the latest Fed minutes signalled ‘inflation had been well below the Committee’s long run objectives, but with oil prices and the foreign exchange value of the dollar stabilising, members expected that inflation would gradually rise towards 2% over the medium term”. Will the dollar stabilise though? Put simply, what is the trade-off between a stronger currency and interest rate decisions – or how far and fast will the Chinese allow their currency to depreciate in coming months? A total move of say 10% would certainly begin to have an impact on GDP, CPI or profits expectations. Even the small moves seen in August have rippled through into the US dollar and therefore commodity prices and the shares of materials companies. In these circumstances, we see future Chinese currency moves as particularly unfavourable for its Asian trading partners, as their currencies come under pressure, and so we remain underweight in these assets.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Citywire Wealth Manager - 3rd September 2015