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Conclusion: To be clear, we think the Chinese are neither incentivized nor inclined to devalue the CNY again – certainly not in the near term. That said, however, we believe another round of euro debasement out of the ECB is likely the next catalyst for investors to begin pricing in this risk – rightly or wrongly.

According to the [unofficial] Caixin-Markit Manufacturing PMI series, Chinese growth slowed to a 78-month low in September, with the Output sub-index dropping to a lowly 45.7 from 46.4 in August. There are two things investors should takeaway from this release:

  1. Contrary to the opinions of our perceived competitors, global growth continues to slow – even on their preferred metric (i.e. Manufacturing PMIs). For reference, even after its demonstrable slowdown in recent years, China alone still accounts for over a quarter of all global GDP growth.
  2. The aforementioned figure weighed on mainland and regional equity bourses and prompted speculation of another round of CNY debasement, which we find to be misguided – at least at the current juncture.

When Will China Devalue Again? - MANUFACTURING PMI

Per official rhetoric, the early August devaluation of the CNY wasn’t designed to stimulate exports, but rather to better align the currency with “market forces”.  As such, investors should not expect another CNY devaluation to the extent the market rate and reference rate remain in synch, which has been the case since the devaluation.

When Will China Devalue Again? - CNY Reference Rate Spread

We can take their word for it given that: A) said devaluation was really small in magnitude; and B) the CNY had hardly moved against the currencies of China’s two largest export markets (USD and HKD). Regarding the latter point, the CNY had actually declined -0.9% YoY vs. the USD and -1% YoY vs. the HKD on the day prior to the devaluation.

When Will China Devalue Again? - China Exports by Destination Market

Obviously China could stand to benefit from incremental currency debasement given the deflationary pressures emanating across its economy; we discuss these dynamics is great detail on slides 7-13 of our recent presentation on China (CLICK HERE to access).

When Will China Devalue Again? - PPI

That said, however, subsequent devaluations may ultimately equate to China shooting itself in the foot, given the current degree of capital outflow pressure evident in both the data and in market prices. It may also serve to derail China’s hopes of achieving reserve currency status at/with the IMF (CLICK HERE for a thorough discussion of those dynamics).

When Will China Devalue Again? - China Capital Flows

When Will China Devalue Again? - CNY Forward Spread

One could make the case that if the devaluation was designed to make China more competitive vs. the Eurozone (China’s third largest single export market at 11.4%), on the margin, then the PBoC has a lot more hay to bale. The CNY is still up +10.2% YoY and +20.1% over the past 18M vs. the EUR as a result of its managed float vs. the USD.

Given that our #EuropeSlowing theme implies that we expect the ECB to officially expand its QE program by year-end, an incremental devaluation of the euro should turn investor attention back to the specter of CNY debasement – rightly or wrongly. For now, we remain in the latter camp (i.e. “wrongly”), but are certainly not of the mind to pooh-pooh the risk of another round of China-induced global financial market volatility.

Email us with any questions, comments or additional concerns.


Darius Dale