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Overview
The yuan’s recent fall is the largest seen since the August 2015 devaluation. There are several differences compared to then, but the key underlying imbalances of the Chinese economy that prompted the devaluation are little changed. China continues to repress the household sector to the benefit of the SOE and exports. This means China produces much more than the household sector can consume, and so China must export the surplus abroad.
Household consumption relative to GDP, after rising for a few years, is falling again. China is allowing the yuan to ease to alleviate pressure on employment from tighter credit and Covid-driven shortfalls in demand. However, an artificially weaker yuan leads to a larger trade surplus, further stoking imbalances. The risk with allowing the yuan to weaken is it can beget more capital outflow, putting further pressure on the currency. This was what happened in 2015.
Chart 1: Chinese yuan surprise weakness against the USD – USDCNH – Chinese offshore exchange rate
Source: Bloomberg
Increased tension with Russia is just the latest risk that’s making stocks jumpy, adding to the perils of soaring bond yields and inflation forecasts that while receding, remain elevated.
All of that has made for a difficult April in what is historically the best month of the year for equities. For investors awash with liquidity, there aren’t many good places to hide, with the exception of cash. Yet for those wanting to reduce risk, there’s a catch: low trading liquidity largely explained by the absence of large institutional investors.
Chart 2: S&P500 Trading Liquidity
Source: Bloomberg
The yen is heading for its worst month against the dollar since November 2016 – when Donald Trump won the Presidential election. The losses probably have further to go.
The BOJ is sticking to its powerful easing buying unlimited amounts of bonds to maintain the 0.25% yield target – quite a contrast to the rate hikes and quantitative tightening emerging elsewhere.
The relentless decline in the Japanese yen has failed to lift Japanese stocks – the close correlation has broken down recently. That suggests there’s been limited benefits for corporate earnings from a weaker exchange rate so far.
Chart 3: Weaker yen not supporting Japanese equities
Source: Bloomberg
