What is happening on the Chinese markets?

On 6 January, the PBoC surprised market participants by setting the Yuan lower than the previous day's closing, contravening the new rule it had itself established last August. Many feared that this move might signal a wish to precipitate a weakening of the Yuan.

While this sudden change in the fixing process has been clumsy, we do not believe it marks the beginning of a sharp downward adjustment of the Yuan in effective terms. In recent years, the Yuan has indeed significantly appreciated against its main trading partners’ currencies while remaining almost stable against the dollar, and while many other – notably Asian – currencies weakened against the dollar. This divergence between, on the one hand, a depreciating Yuan against the dollar and, on the other, an effective appreciation against all currencies, continued in 2015 while China's activity was clearly slowing down (see chart below). In December, before the Fed lift-off, the PBoC announced that CFETS, a subsidiary of PBoC, would regularly publish an RMB exchange-rate index which “will help guide market participants to shift their focus from the bilateral RMB/USD exchange rate to the effective exchange rate, which is based on a basket of currencies.” (PBoC, Dec 11th, 2015.)

We thus tend to interpret the recent depreciation of the Yuan against the dollar more as a correction of past Yuan appreciation than as a radical change in the PBoC's exchange-rate policy.

That said, Chinese communication and confusing messages since the summer have durably eroded market participants’ confidence. While some depreciation of the Renminbi against the dollar is justified, a stronger depreciation of the currency would, however, be a major risk to our scenario. We continue to believe China will not let this happen and will manage its currency through regular interventions when needed. The risk is that the authorities will have difficulties managing the USD/CNH depreciation on the offshore market and depreciation expectations continue to accumulate on the onshore market. Signs of economic growth stabilization should, however, support the PBoC’s actions. Helped by increased visibility on the management of the Renminbi effective exchange rate – i.e. not against the USD alone – market nervousness should progressively recede.

Increased risk aversion and volatility since the beginning of the year should therefore gradually come down and allow developed equity markets to reflect sounder fundamentals. Developed-market economic indicators have, indeed, remained well-oriented since December, in particular in the Eurozone. We are therefore keeping our strategic bias in favour of DM equities (in particular European equities) for the time being.

The impact on the Chinese equity market should, on the contrary, be longer-lasting. Although market valuation (MSCI China) is attractive and economic publication globally in line with expectations, interventions and mistakes in communication have increased risks and will make it harder for Chinese markets to truly reflect fundamentals. We would for the time being not directly renew with exposure to the Chinese market.

Asset Allocation Team & Macro Team