Last week we noted how China was preparing to remove a key form of support for its steel industry, by removing an export rebate.
Without this rebate, smaller, higher-cost Chinese steelmakers will be less competitive on the global market for steel.
That's why Chinese steel players are particularly worried about any upcoming adjustment to the yuan-dollar exchange rate. It would amount to a double penalty for exporters.
"Chinese steel exports have had no chance in recent weeks, even though our hot rolled coil on FOB terms is cheaper than that from India or Russia -- a more flexible currency, which means growing appreciation, will have a big impact," said a steel export manager based in Beijing. But the trader said the move could at least put a stop to recent proposals aimed at reducing tax breaks to steel exporters.
"I don't think China will try a double-strike of export tax rebate cuts and yuan currency revaluation -- the government may slow down its plans."
"The cost burden could fall slightly, but no one buying iron ore is expecting the margin of revaluation to be particularly large," said Xu Guangjian, an iron ore analyst with the Umetal consultancy in Beijing.
"The deciding factor right now is still the supply-demand situation, particularly downstream demand in the third quarter."
Industry optimists are thus hoping that yuan-adjustment talk is mostly hot air, that there won't be any significant adjustment to the yuan-dollar rate any time soon.
Still, should the pessimists prove correct, then global markets for commodities that feed into steel, ie. iron ore and coking coal, could be in for a shock should a substantial yuan hike combine with the removal of China's export rebates. Such a shock could then feed into dry bulk shipping weakness (for companies such as DryShips (NASDAQ:DRYS), Diana (NYSE:DSX), or Excel Maritime (NYSE:EXM)), given that Chinese iron ore consumption has been a primary demand driver.
The Baltic Dry Index (BDI) has tanked as of late, but it remains at a historically decent level. It can go much lower should demand growth collapse, caused by pain in China's steel sector. This isn't a prediction of the most likely scenario, but it's a long-tail risk with huge consequences for commodities and the ships that carry them.
Disclosure: No positions