Market Uncertainty Continues as the Chinese Yuan Drops to a 5-year Low

Chinese Yuan

Chinese Yuan

With ever-increasing volatility and continued fall in the Chinese equity markets, we have now seen a fall in the Chinese Yuan. Chinese Yuan versus the U.S. dollar declined to 6.5646 per dollar on Jan. 7, the lowest since March 2011. Official exchange rates which are tightly controlled by the Chinese government and are limited to a 2% move. This does not take into effect the Offshore Renminbi Trading in Hong Kong which indicates an even weaker Yuan. The spread between these two markets had widened to record levels, and now Chinese officials stepped in. China has now instituted new reserve requirements on banks to curb offshore speculation of the RMB. There is a great deal of skepticism as to whether or not this will have any impact on the Yuan’s continued demise.

The fall in the RMB has a far greater impact on global markets than the fall in Chinese equity markets does. As the value of the currency depreciates so does the purchasing power of the world’s second-largest economy and the driver of global growth. The oil market is a perfect example of this as a large reduction in demand from China has driven the price to multi-year lows. The drop in the yuan has also led to a steep fall in commodities prices impacting countries like Australia which rely heavily on Chinese imports.

One of the biggest fears as result of the Yuan decline is that it could lead to a currency war. Countries would make protecting their exports a priority and as a result would look to devalue their currency to remain competitive.

One of the most significant contributing factors to the continued fall of the Yuan is the recent and sustained strength of the US dollar. With the outlook for four incremental rate hikes, the question remains if the Federal Reserve will change its tune with continued market uncertainty.