Until the next shock in the Chinese yuan
While it seems like the Chinese exchange rate has returned to normalcy, markets should anticipate surprises
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If you cast your eyes on the chart alongside, you’ll see a sharp fall in both the S&P 500 index and the BSE Sensex at the beginning of August last year and in early January this year. Both these dates mark a sudden sharp depreciation of the Chinese currency.
So, in the last eight months, whenever China has devalued its currency, there has been a sharp sell-off in the global markets. In mid-August, when the yuan depreciated by 3.2% in a span of 13 trading sessions, the Sensex slumped 8.5% and the S&P 500 plunged almost 8%. In the first week of January again, investors were left with a feeling of déjà vu as China decided to fix the yuan at lower levels. The yuan declined by around 1.4%, which led to a 7.7% slump in the Sensex and a 6.9% slide in the S&P 500 in a span of six trading sessions.
But this is history. What’s interesting is what happened to the markets after these episodes. The chart shows that the Sensex made a W-shaped fall and recovery last August, a pattern that was followed almost to the letter after the January yuan depreciation. That W-shaped pattern is seen in the S&P 500, too. Note that between the two episodes of yuan devaluation, the S&P 500 meandered around the top of the W. The Sensex on the other hand continued to decline slowly, no doubt because of the disenchantment with emerging markets.
What of the future? Will the indices continue to rise till they have reached the levels they were at before the January yuan devaluation? Note that the renminbi has stabilized—in fact, it has strengthened and is trading at the highest level so far this year. This is what has led to a return in the “risk on” environment, no doubt aided and abetted by European Central Bank president Mario Draghi.
If history repeats itself and if you believe the problems in China are too big to be brushed under the carpet, then the big question for the markets is: when will we have the next bout of yuan depreciation? While it seems like the Chinese exchange rate has returned to normalcy, markets should anticipate surprises as People’s Bank of China governor Zhou Xiaochuan himself has said that he “can’t rule out any future fluctuations”.
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