China’s Central Bank has accelerated the pace of the devaluation of the Chinese yuan on Thursday, which has thus further rattled markets as investors fear a “currency war” with further devaluations ahead on the horizon in China and also across the Asian region.
As such, global markets have come crashing down and panic is ensuing.
China halted the day’s trading after only 29 minutes of opening up on Thursday morning as shares crashed by over 7 percent, thus triggering an automatic circuit breaker, the second time this week that this has happened.
China’s recently installed circuit breaker mechanism paused trading for 15 minutes after the CSI300 index fell 5 percent in the first 13 minutes of trading. Upon resumption of trading it fell further, triggering the day’s halt on trading, the second time this week that this happened.
The CSI300 index finished down 7.2 percent, the Shanghai composite index fell 7.3 percent, and Shenzhen index dropped by 8.3%.
Brent crude prices mirrored a chaotic Asian session and also came crashing down on Thursday, falling over 4 percent to the lowest level seen since April 2004.
In the U.S., West Texas Intermediate (WTI) futures were also down around 4 percent to $32.53 per barrel, a December 2008 low. Should prices fall below $32.40 WTI, like Brent, will be at levels that haven’t been seen since 2004.
Oil prices have been dragged down amid a large supply overhang as oil producing countries continue to pump and output levels are at near-records.
The price of oil has now crashed a mind-boggling 70 percent since the downturn started in June 2014, causing significant pain to companies and economies that rely heavily on oil revenues.
Currency Wars: Another Devaluation From the PBOC
China surprised markets on Thursday by accelerating the devaluation of the yuan to its lowest level in nearly five years.
The move sent regional currencies tumbling, as investors fear a currency war as China starts a virtual trade war against its competitors.
China’s Central Bank, The People’s Bank of China (PBOC) set the official midpoint rate of the currency at 6.5646 yuan per dollar, the lowest level since March 2011.
The midpoint rate set was 0.5 percent weaker than the previous day and was the biggest daily drop since August 2015, when the PBOC made a surprise move with a near 2 percent devaluation of the currency which also roiled global markets.
“Markets are nervous — in essence they don’t trust the policy makers in China,” said George Boubouras, chief investment officer at Contango Asset Management in Melbourne. “Investors don’t like the concept of a fast-depreciating yuan, so there’s a lack of confidence.”
U.S. index futures sank overnight going into Thursday morning — the DJIA, S&P500, and NASDAQ all fell over 1 percent.
The Oil Glut
As Chinese markets get hammered, so shall oil, as the yuan continues to depreciate and growth in China slows.
The continued plunge in the price of oil also comes on the back of near-record output from major oil producers such as the Organization of the Petroleum Exporting Countries (OPEC), Russia and North America, which has left storage tanks overflowing with supplies.
“With oil markets producing 1 million barrels a day in excess (of demand) and very little sign of any rational response from the supply side, it’s little wonder we’re seeing pressure again,” said Michael McCarthy, chief market strategist at CMC Markets in Sydney.
The plunge in prices is also causing economic havoc for countries that rely heavily on oil export revenues, such as Saudi Arabia, whom recently slashed their budget and hiked fuel prices.
Saudi’s 5-year credit default swaps (CDS) have more than tripled since late 2015 to over $180.
Oil market woes have been further been exacerbated by weakening demand, particularly in Asia, as China, the number two oil consumer, is seeing its economy slow to the most in a generation.
“The Chinese economy actually contracted in December and that’s adding fire to fears of a more rapid slowdown in the world’s second biggest economy,” McCarthy said.
“We think low $30s (per barrel) is a floor, but once positioning gets so biased anything can happen,” said Virendra Chauhan, an analyst at Energy Aspects in Singapore.
What Next for China’s Markets and the PBOC?
Christopher Balding, a professor of finance and economics at Peking University’s HSBC business school, said that he expected more government action to halt the stock market drops, “whether it is changing the circuit breakers, whether it is again intervening in the market, whether it is extending the ban on large selling by institutions.”
“I’d be surprised if they let this continue going down. By almost any measure, the Chinese stock market is pretty over valued and so you would be looking at a pretty significant fall to get back to a reasonable valuation. I would be surprised if they allowed it to move back to more appropriate levels.”
China’s stock market turbulence has brought back recent memories of when China suffered a humiliating bout of financial chaos that saw the future of the Prime Minister, Li Keqiang, called into question.
“People are definitely nervous. People are paying a lot of attention to this stuff, whether it is the stock market or the changing currency,” said Balding. “I think psychologically the currency issue is a bigger issue for Chinese and it is definitely a bigger issue for a lot of firms. Between the two issues there is a lot of worry right now.”
“The PBOC is unlikely to allow uncontrolled yuan depreciation and they have the firepower to manage the pace and magnitude of weakness, but it is clear that a more flexible and market determined exchange rate regime is quickly evolving,” said Jason Daw, head of Asian foreign exchange strategy at Societe Generale.
Daw expects that the onshore dollar-yuan rate will reach 6.80 by the final quarter of 2016.
A sustained depreciation in the yuan puts pressure on other Asian countries to devalue their currencies in order to stay competitive with China’s massive export machine.
In addition, a sustained depreciation in the yuan also makes commodities denominated in U.S. dollars more expensive for Chinese buyers, which could hurt demand and thus further depress commodity prices.
“It appears at least initially that the Chinese government is telling the market that they are going to steer the RMB [yuan] closer and they are not going to intervene in the stock market,” said Balding. “But they have done this before when they don’t exactly rush to maintain it and they don’t tell people that everything is going to be OK and the market craters for a couple of days and then they step in. So whether or not this maintains through even tomorrow, who really knows?”
The “Perfect Storm”
Prior to the devaluation event from China, which resulted in associated market turmoil, a cautionary message was issued:
The World Bank issued a warning on Wednesday that the global economy could be battered by a “perfect storm” in 2016 as a synchronized slowdown in BRICS economies could be intensified by a fresh round of financial turmoil.
The World Bank said that BRICS nations — Brazil, Russia, India, China, and South Africa — could all face problems simultaneously which could have spillover effects for the rest of the world economy.
China’s 2016 growth forecast was also trimmed by the World Bank to 6.7 percent, from a previous estimate in June for 7 percent growth.
So as we enter into 2016, as China continues to slow, as everyone has expected, how much further will China devalue? How much more will OPEC nations keep pumping? How much further will markets unravel?
I believe we have reached the tip of the iceberg of the next financial crisis and the pain has only begun.
Whatever your next move may be, think it through and be wise!