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China Devalues Currency: What This Means for World Markets

In a move that surprised the world’s financial markets on August 12, China devalued its currency for a second day running. The move indicates that the world’s second-largest economy is weaker than expected and is taking measures to boost its economy. The devaluation has also prompted fears of a currency war that could destabilise the world economy.

What happened?

The People’s Bank of China (PBOC) changed the method by which it fixes the Chinese Yuan (CNY) exchange rate. It will no longer be pegged exclusively to the U.S. dollar. The exchange rate target is now based on the CNY’s previous closing and also takes into account the CNY’s supply/demand as well as the valuation of other currencies.

The depreciation of the CNY over the past two days amounts to 3%; however, since it was pegged to the USD, the devaluation is only fractional when comparing it to the gain since the USD rallied from its lows of 2011.

Why did China devalue its currency?

The devaluation follows the release of weaker than expected economic data recently. China’s latest export data is disappointing given the strength of the U.S. dollar. By depreciating the value of its currency, China is effectively making its exports cheaper and therefore more competitive.

China’s factory output for July also missed expectations. The Caixin Composite Output Index posted only fractionally above the neutral 50.0 mark at 50.2, down from 50.6 in June, and pointed to the weakest rate of expansion in 14 months. July export growth was -8.3% (China’s 2015 target is 6%) and‎ industrial production in July grew only 6% compared to 6.8% in June.

What does the devaluation mean for the region and for Canada?

This change in policy has implications for the region. Other Asian countries with significant trade linkages with China are likely to let their currency depreciate against the U.S. dollar in order to maintain competitiveness against China. The main currencies in that group are the Korean won, the Singapore dollar and the Taiwanese dollar.

A weaker CNY also implies decreasing Chinese purchasing power to buy commodities since they are priced in U.S. dollars. At the margin, this CNY devaluation is negative for commodities and commodities currencies as well (Canadian dollar, Australian dollar, New Zealand Dollar, Malaysian ringgit).

What is the impact on MD Portfolios?

MD’s portfolios are diversified across all geographic regions and well positioned for equity market volatility. Within MD Portfolios, allocation to Emerging Market equities (which include China) represents a small portion of the portfolio (3% within the 10+ year time horizon portfolio) and less volatile domestic fixed income has a meaningful allocation (43% in 10+ year time horizon portfolio) to offset equity market volatility. In addition, MD’s unique currency strategy is currently positioned to avoid allocations to currencies with strong ties to commodities, particularly in the Emerging Market mandate.

We encourage you to speak with your MD Advisor if you have any questions about your portfolio. Your MD Advisor can work with you to ensure your portfolio is diversified and well positioned to withstand market volatility.