Why The Chinese Yuan Matters

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Includes: CNY, CYB, FXCH
by: CME Group
Summary

On August 5, the Chinese yuan weakened below 7 per dollar for the first time in 11 years.

Within the current geopolitical climate, the drop below 7 yuan per dollar is seen throughout the world as retaliation against the latest U.S. tariffs and indicates that there is no end to the trade war in sight.

Markets around the world felt a ripple effect following the yuan's drop.

Originally posted on September 3, 2019

By Scott Bauer

At a Glance

  • Markets around the world felt a ripple effect following the yuan dropping below 7 per dollar.
  • A sudden depreciation in the yuan could put heavy pressure on other Asian currencies.

On August 5, the Chinese yuan weakened below 7 per dollar for the first time in 11 years. The last time this happened was just prior to the Global Financial Crisis in February 2008.

Unlike other currencies, the yuan is not freely traded. This means every day the Chinese government fixes the rate and aims to maintain a 2 percent window in which the currency can fluctuate. In 2016, China set a precedent to keep the yuan above a floor of 7 per dollar, and although there is no official policy constituting the Chinese government to maintain this floor, it is an important psychological benchmark for the government and world economy.

Within the current geopolitical climate, the drop below 7 yuan per dollar is seen throughout the world as retaliation against the latest U.S. tariffs and indicates that there is no end to the trade war in sight.

Ripple Effects of Weaker Yuan

Although the yuan is directly tied to the U.S. dollar, China and the United States are not the only countries affected by a weaker yuan. Markets around the world felt a ripple effect following the yuan dropping below 7 per dollar in early August as Asian and European indexes dropped, and investors sought safety in government-backed bonds, such as the Japanese yen.

The MSCI Asian Pacific Index, a benchmark of large- and mid-cap representatives within the Asia-Pacific region, has dropped 3.5 percent since the start of August, a direct indicator of the effect that the yuan devaluation is having within the region. The U.S 10-year treasury yield also fell to nearly a historic low, below 1.6 percent.

China's currency devaluation is an important story to monitor because of how it affects the entire region. An excessive and sudden depreciation on the yuan could put heavy pressure on other Asian currencies, and a much weaker yuan could inflict pain on Chinese importers.

Slowing Growth Rate

The ongoing trade war with the United States is front and center, but it is not the only story that needs to be closely watched. Demonstrations in Hong Kong over the proposed extradition bill have been raging nonstop for over four months, setting up a very delicate and volatile situation for one of the world's most important financial hubs. These geopolitical risks can affect global markets, and two significant economic numbers coming out of China to closely monitor are their GDP and interest rates.

China is one of the world's largest economies in terms of GDP and growth. Cyclical factors as well as the prolonged trade war have caused the growth rate to slump to 6.2 percent in the second quarter of 2019, the lowest quarterly growth since 1992.

According to the country's National Bureau of Statistics, the Chinese economy will continue to face downward pressure in 2019. As the trade war plays out, China's GDP will be representative of how the globe's geopolitical climate is taking shape.

A New Interest Rate in China

Additionally, the People's Bank of China, the Chinese central bank, is under extreme pressure to help boost the economy and has recently introduced a long-awaited change to its interest rate policy.

The new interest rate is an attempt to boost lending to privately run, smaller businesses and is significantly lower than previous rates which have not been adjusted since 2015. The interest rate is also important to take note of, because it can be interpreted as an indicator of China's confidence in its economy and where they feel they are within the economic cycle if they adjust rates to attempt to boost growth.

There are several factors to watch, but one thing is for certain: the decision by the Chinese government to fix its currency to its lowest value in 11 years affects far more than those using the yuan within China.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.