The turmoil in the world’s financial markets has been led by the Chinese economy and the US Federal Reserve bank. Two factors have happened concurrently. First, economic growth in China has slowed, causing downward pressure on the value of its currency. Until August 11, China had maintained a fixed rate of 6.2 yuan (about R12.664) per dollar.
When market forces sought to depreciate the yuan, China’s central bank – the People’s Bank of China (PBoC) – sold foreign exchange reserves in exchange for yuan, boosting the value of the yuan just enough to keep the rate fixed. With increasing pressure, however, this practice becomes more and more expensive.
Second, the US economy showed signs of recovery. Combined with a market expectation that the Federal Reserve Bank would increase the interest rate in September, the demand for dollars increased and the dollar appreciated. The deviation of the yuan’s value relative to the dollar eventually proved too much for China’s interventionist strategies and on August 11, the PBoC surprised the market with an official 3.5 percent depreciation of the yuan.
This was not built into asset or trade prices and instead of the market seeing this as a responsible readjustment of the yuan’s value, it signalled that the state of the Chinese economy must be worse than previously thought. Investors feared that this was only the first of many devaluations and started pulling their money out of yuan-based assets and towards dollar and yen based portfolios.
Last Monday, the Shanghai composite index dropped 8.5 percent and the value of the dollar and the Japanese yen (a regional safe haven) strengthened. The losses in China spilled over to regional markets and the major stock exchanges in Japan, Hong Kong and Australia all lost more than 4 percent of their value.
Rush towards bonds
Money was channelled towards US and European bonds. As the demand for bonds increases, the price increases with it and the relative interest return earned on these bonds drops. The rush towards US treasury bonds caused the yield on the 10-year treasury note to sink briefly to 1.9 percent on Monday before recovering slightly to just more than 2 percent.
The fear of a severe economic slowdown in China has knock-on effects for growth in all emerging markets. China accounts for 65 percent of the world’s iron ore imports, 40 percent of copper imports, and is second only to the US for oil imports. It is also South Africa’s largest export market accounting for 11.7 percent of total exports.
Emerging market currencies were already depreciating due to the rising strength of the dollar, but concern over growth has caused investors to take a more negative stance on these currencies, leading them to pull their money away from emerging markets and amplify the depreciation that was speculated.
Due to the exposure of US companies to global markets, the losses in the Asian stock exchanges led investors to sell out of US stocks. The decreases in the Dow Jones industrial average, Standard & Poor’s 500, and Nasdaq composite indices picked up a peculiar momentum, however, and have continued to slide since last Monday.
The losses are unusually large and rapid to be linked solely to crashes in the Asian markets. It suggests that given the dampened outlook on global growth, investors are reconsidering whether the Fed will increase US interest rates this year and are redrawing the value they have been building into the market in anticipation of a greater dollar appreciation.
The rand is playing second fiddle to international portfolio flows and while domestic issues have given the rand a low base to start from, current depreciation is being driven by global factors.
* Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein
BUSINESS REPORT