The Chinese Devaluation ContinuesMay 11, 2022
Just today, as US inflation came in a touch hotter than expected, the Chinese Yuan is pulling lower, testing the lows of May 9, 2022. The five-day rate of change is fairly extreme by anything we’ve seen over the last few years. The last time we experienced a weekly 3% drawdown was in 2015 as China was attempting to stimulate its economy.
The total devaluation so far is about 7%, which is roughly half of the 2015/16 and 2018-20 devaluations. So, there is probably more to go, especially given the relatively wide spread between the onshore (CNY) and offshore (CNH) Yuan. When this spread increases, it is historically indicative of money trying to leave the country.
The devaluations usually have a quick downward impact on prices. For instance, if we look at import prices from China, they track changes in the CNY closely. This suggests that import prices from China have peaked, providing a tailwind for the inflation “peaking” story.
I suspect we’ll see the impact in ISM Manufacturing Prices Index fairly soon at the devaluation bites.
These devaluations historically have been well correlated with US Treasury rates as well, and the recent devaluation provides a somewhat rosier picture for those looking to add some duration to their portfolio. It probably isn’t a coincidence that 10-Year US Treasuries have turned lower in yield as the devaluation hit.
The conduit for lower rates alongside a weakening CNY is the impact on inflation. With this in mind, it isn’t surprising that breakeven inflation peaked as the CNY rolled over. This provides the possibility that falling breakeven inflation rates may contribute to lower rates.
In recent bond market sell-offs, the term premium has really been the balance of adjustment pulling rates higher. But, the term premium is also well correlated to the CNY, and the recent decline argues that the 60bps increase in the term premium experienced recently will be turned down, especially given further devaluation.
As most are probably aware, the Chinese government has made numerous intrusions into the economy in areas ranging from education to internet services, to food delivery and ride sharing. This has not been taken well by the stock market. In the chart below I plot the China CSI 300 Index relative to 10-Year Chinese government bonds and compare to the CNY.
Continued underperformance of Chinese stocks vs. bonds could pull the CNY all the way to 7, which would constitute a more historic 12-15% devaluation. Should this come to pass, China will be actively contributing to bringing inflation down in the US, which, after today’s report, is something the US is still seeking.