People’s Bank Signals That Yuan Devaluation Will Be Orderly

U.S. stocks rallied strongly today, Thursday, August 8, after the People’s Bank of China set its daily reference rate for its currency at 7.0039 to the dollar. That was stronger than the 7.0156 yuan to the dollar overnight estimate of 21 analysts and trader surveyed by Bloomberg. (The bank sets a middle point for the yuan for the day using a complex formula based on trading in other global currencies. The bank then allows the the value of the yuan to float within a strict 2% plus or minus band from that fix. The People’s Bank has extraordinary power over the value of the yuan since investors who want to exchange dollars or another foreign currency for yuan must sell them directly to China’s central bank.)

Let’s be clear on what the central bank did and didn’t signal today.

By setting the fix below the psychologically important 7 yuan to the dollar level, the bank signaled that it won’t defend that price. The yuan will be allowed to move lower against the dollar.

But by setting the fix at a higher yuan to dollar exchange rate than the market expected, the People’s Bank also signaled that the downward move in the yuan will be orderly. No plunge. No panic. Just a managed devaluation. (Assuming, for the moment, that the People’s Bank, like all central banks, is all-knowing and all-powerful.)

The yuan is down 3.7% in the past three months, and at its lowest since at least 2015 against a basket of currencies from 24 trading partners, according to Bloomberg.

Wall Street continued to project a deep decline in the value of the yuan with some analysts now talking about 7.7 yuan to the dollar by year end. On Monday and Tuesday the conversation was about a drop in the yuan to 7.5 to the dollar by the end of 2019.)  But today’s action, the market concluded today, means that the People’s Bank will manage the devaluation to minimize capital outflows from China that could rattle the global economy and other major trading currencies.

The Standard & Poor’s 500 closed today up 1.88%. The Dow Jones Industrial Average was ahead 1.43%. And the NASDAQ Composite was higher by 2.24%. Technology stocks did particularly well today with the Technology Select Sector SPDR ETF (XLK) closing up 2.45% on the day.

Importantly, investors and traders didn’t see today’s stock market recovery as a reason to sell risk-off assets that will rise in price with a slowing global economy or lower U.S. interest rates. The Gold Shares ETF (GLD) was up 0.50% and a gold stock such as Barrick Gold GOLD) climbed 0.78%. The gold miner stock ETF (GDX) and the junior gold miner stock ETF (GDXJ) rose 1.74% and 1.58%, respectively.