China Currency War Contagion Spills Out, Leads To Global FX Heatmap Bloodbath, PBOC Intervention

Overnight, as previously reported, the world was shocked to find that following the record 1.9% devaluation yesterday, China's ongoing attempt to bring its currency into balance was not a "one-off" thing as the PBOC desperately wanted to spin it, but tumbled by 1.6% again just this morning to a 6.3306 fixing, the lowest since October 2012.


That was just the start of the bad news: shortly after the second devaluation in a row, China reported retail sales (10.5%, exp. 10.6%) and Industrial output (6.0%, exp. 6.6%) which both missed expectations. As Goldman summarized "July activity data came in below market expectations. IP growth moderated meaningfully from June both in yoy terms and on a sequential basis. In conjunction with other recent weak data such as the July trade report, these indicators (which senior officials would have had earlier) help explain the move weaker in the currency over the past two days."


3Q GDP growth faces significant further downward pressures as the economy will hit a bump in August and September. Beijing and its surrounding regions, the most important heavy industrial zone in the country, will restrict construction, production and transportation between 20 August and 4 September. All previous such restrictions (Olympics in 2008, Youth Olympics and APEC Summit in 2014) were associated with weak growth. With the A-share equity market range-bound amid intensive government supports, the extra 0.5ppt direct contribution from heightened financial sector activity to first-half GDP growth will likely fade too.


Today's data at least partially explains the two very unusual moves by the PBOC yesterday: (1) the decision to allow the currency to depreciate, (2) releasing very strong (at least on the surface, see China: July money and credit data above expectations, but underlying growth not as strong as headline numbers suggest, Aug 11, 2015) July monetary data very early in the morning. The moves were likely intended to be a preemptive measure to show the market the economy has a brighter side too and the government is taking actions to support growth.


We expect the government to take other loosening measures, including further RRR cuts, more supports for policy banks, more government bond issuance, and pressures on local governments to take actions to spend idle fiscal deposits to support FAI growth. Slightly higher recent CPI inflation may make policymakers a bit more reluctant to ease via (benchmark) rate cuts than through the other approaches -- in the past, policymakers have seemed to view benchmark rates as more closely linked to inflation outcomes, though we think their impact on the economy is relatively modest.


And so overnight the world realized that there is much more devaluation to come,  which in turn led to a tidal move higher in the EURUSD as the European banks who had been short the EURCNH (probably the same ones that were long the EURCHF in January ahead of the SNB shocker) continued covering their exposure, and in turn pushed the EURUSD well above 1.11, while the CHF continued to tumble alongside the USD at least when it comes to Europe.

In Asia, and local emerging markets, however, it was a different FX story eniterly. To wit:


A more detailed look courtesy of Bloomberg:

  • Onshore and offshore yuan lead declines among Asian currencies after China weakens yuan fixing by more than 1% for second successive day; sovereign bonds rise in Australia, while interest-rate swaps climb in Malaysia.
  • Aussie falls against dollar; Australia’s second-quarter private-sector wage growth was lowest on record
  • Won touches weakest level since Oct. 2011; South Korea’s jobless rate fell to 3.7% in July from 3.9% prior month; nation is closely monitoring foreign-exchange market as China’s yuan devaluation, along with Fed’s possible rate increase, is raising volatility in financial markets: Finance Minister Choi
  • Rupiah touches weakest level since 1998; Bank Indonesia sees rupiah’s recent declines as excessive, causing currency to trade far below fundamental value, Governor Martowardojo says; central bank will remain in market to stabilize rupiah, bonds, sees second-quarter current-account deficit at 2.3% of GDP; nation announced changes to President Widodo’s cabinet; government to guard economic fundamentals in responding to market losses, Finance Minister Brodjonegoro says
  • Rupee drops; India’s industrial production probably advanced 3.5% in June from year earlier after increasing 2.7% in May: Bloomberg survey; consumer prices may have risen 4.4% in July following 5.4% increase in June: separate survey; both sets of data due today
  • Peso declines; Philippines has sufficient liquidity, remittances to buoy peso amid yuan drop, central bank Deputy Governor Guinigundo says
  • Dong slumps; Vietnam widens dong’s trading band to plus/minus 2%

But perhaps the best way to visualize what is going on in China relative to the USD is with a simple heatmap:


The contagion from the deflation-exporting currency war promptly spilled over into Europe, where German 2 Year bonds dropped to a record -0.29% while the 5 year went negative for the first time since June 1. For now at least the 10Y is still above 0.60%, although expect that to slide as well: moments ago the 5Y5Y inflation swap rate fell to under 1.70%, the lowest since April 28, and confirming that the next deflationary wave in Europe has arrived.

All of this was as we expected and explained would happen yesterday.

Perhaps the only surprising wrinkle is that as the Offshore Yuan was crashing, first by 2%, then by 3%, the PBOC intervened.

A sudden drop in USD/CNH from 6.5900 to 6.5600 came after suspected onshore USD/CNY selling by agent banks, according to an FX trader based in North Asia. This was the PBOC making itself felt in the offshore market. In fact there were at least two interventions in the Yuan market that we can see as of this writing. As a result the Yuan fell 1.0% to 6.3870 per dollar after dropping by as much as 2.0% ealier before the PBOC got involved.

Furthermore, it appears that much more intervention is in store:


More from Bloomberg:

  • China’s forex regulator issued notices to banks on Wednesday, asking them to limit dollar purchases by some cos., according to people familiar with the matter.  Order doesn’t affect those having valid trade-related demand, said the people, who declined to be named as the matter isn’t public
  • Some cos. were making large dollar purchases that may have been related to exploiting the difference in exchange rates between the onshore and offshore yuan markets, according to one person
  • SAFE also gave verbal guidance on the matter to some banks on Tuesday, two people said. Affected transactions could be in either spot, forwards or options markets, according to one person

WSJ adds more:

China intervened on Wednesday to prop up the yuan in the last minutes of trading, according to people familiar with the matter, in an apparent attempt to prevent an excessive fall in the currency as the authorities seek to give the market more say in setting the exchange rate.

The PBOC then instructed state-owned Chinese banks to sell dollars on its behalf in the last 15 minutes of Wednesday’s trading, according to the people. The result: The yuan jumped about 1% in value against the dollar in the final moments of trading, bringing it to a level where one dollar would buy 6.3870 yuan.

And if China's hilarious attempts to stabilize its stock market were mostly a sideshow for foreigners, now that China is actively managing its currency from the market standpoint, all those smiles have promptly turned to frowns, as suddenly nobody has any idea what to expect out of China.

The end result of the second day of Chinese intervention: US equity futures are currently down 1.2% to 2058, far below the 200 DMA, while the 10Y is at 2.07%, and on its way to a 1 handle in the coming days if not hours.