The Overnight Report: Reversal

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By Greg Peel

Float on By

Perhaps we can blame the IMF, which told Beijing recently, in rejecting China’s application for the renminbi to be included in the fund’s basket of global reserve currencies, that Beijing must first let the renminbi float. A PBoC devaluation is not a float, but the intention is to take a step towards such a goal. Yesterday the PBoC followed up Tuesday’s 1.9% renminbi devaluation with a further 1.6%.

The central bank did so because that’s where the market was indicating the renminbi should be. The Chinese currency is pegged only to the US dollar, and in revaluing the currency over the past several years against the greenback alone, the PBoC has failed to account for large valuation variances against other major currencies, such as the yen and euro. In devaluing, the PBoC is trying to find the right overall level.

The problem yesterday was that the PBoC responded to the market but then the market went again, selling the renminbi down further in what threatened to become a self-feeding spiral. Thus on the close of trade in China (long after the close on Bridge Street) the central bank intervened to stabilise the currency.

This is not a sinister response – every central bank, including the RBA, intervenes on occasion to prevent excessive currency volatility.

But it does show that Beijing is nervous, and highlights that the Chinese government is rather new to this game. The stock market debacle of last month was enough to give them the willies and so yesterday they got a little jumpy again. The issue for the rest of the world is one of just how bad is the Chinese economy right now? While the currency devaluation may have come at the IMF’s behest, there’s no masking the fact this is Beijing’s “shock & awe” stimulus tactic.

But as opposed to Beijing’s massive fiscal stimulus package of 2008, this form of stimulus is linked directly into the global financial market system. There is now great concern what the impact will be on Other Asia, which is so closely tied to the Chinese economy, and to emerging market colleagues such as Brazil, which is already struggling, and to the economies of China’s major export competitors such as Japan and Germany, who now see their respective QE measures – to date showing relative signs of success – undermined.

And what does it mean for Australia?

Delayed Reaction

I can admit now Tuesday’s action on Bridge Street had left me somewhat confused. In the wake of the first renminbi devaluation, why did the materials and energy sectors stubbornly rise 1% on the day, when all other sectors fell, as if the previous night’s jump in metal prices was all that mattered? Was a 1.5% plunge in the Aussie in sympathy really enough to negate the impact?

Looking at yesterday’s action I can only assume Bridge Street did not know how to respond. By yesterday morning, following big overnight falls in commodity prices and on Wall Street, it was clear. The materials and energy sectors both plunged over 3%.

It was a perfect storm. Chinese currency aside, we saw poorly received earnings reports from the likes of Computershare ((CPU)), CSL ((CSL)), Carsales.com ((CAR)) and REA Group ((REA)). And in opening lower from the bell, the ASX200 broke down out of its longstanding trading range. From there we could throw in the technical trade. First stop 5380, next stop 5100.

And where did we stop? 5380.

Bear in mind also that the biggest stock on the market – Commonwealth Bank ((CBA)) – was in a trading halt, having announced a 10% discounted $5bn rights issue.

Rebound

Mario Draghi must be shaking his head in despair. The QE package he introduced earlier in the year had, in the background of the whole Greek farce, been quietly working. Major export economy Germany, along with France and others, had begun to see economic improvement. And now this.

The German and French stock markets dropped over 2% each on Tuesday night, and another 3% plus each last night. When Wall Street opened, mid-session in Europe, the selling flowed across the pond.  In the first hour of trade in New York the Dow was down 277 points on heavy volume. But at the same time, the S&P500 reached the bottom of its 2015 trading range.

The selling suddenly stopped. On lower volume, Wall Street began to turnaround. Whether it be bargain hunting, short covering or both, the indices ran all the way back to square.

One consideration is that the renminbi devaluation may once and for all take September off the table as the Fed’s lift-off date. Maybe 2015 altogether. Although there is still debate. Whatever the case, the US dollar index fell 0.9% last night to 96.31, suggesting a delay is now the pervading expectation.

The US ten-year bond yield had seen its big fall the day before, and last night was only down another point to 2.13%.

The plunge in the greenback is not good news for the Australian economy. Having fallen a cent on the first renminbi devaluation, the Aussie fell another half a cent on yesterday’s second devaluation. If the Aussie could keep roughly in step with the renminbi, then the AUD-RMB trade impact would be negated. But alas, on the fall in the greenback the Aussie is this morning 0.8 of a cent higher than it was 24 hours ago, and about 1.3 cents higher than its nadir following the second devaluation. It is less than half a cent lower than where it was when the first devaluation was announced.

Commodities

Base metal prices fell again from the open on the LME last night, having plunged on Tuesday night, but then the buyers arrived. Aluminium, nickel and tin still closed lower on the day but copper rebounded 0.7%, lead 1.6% and zinc 1.8%.

Volumes were heavy, as at least some traders were prepared to “look through” the immediate impact of the renminbi devaluation to its intended goal – to stimulate China’s flagging export economy. Growth in exports means growth in raw material demand, albeit at a higher implicit price for the Chinese.

The oils also stabilised, with West Texas closing up US12c to US$43.33/bbl and Brent closing up US35c to US$49.76/bbl.

Iron ore ticked down US10c to US$55.80/t.

The US dollar drop finally sparked some life into gold, implicit of the Fed delaying its rate hike. Gold is up US$16.80 to US$1125.50/oz.

Today

The SPI Overnight closed up 24 points or 0.4%, suggesting that at this stage, the 5380 technical support level in the physical might hold.

Reporting highlights today include Crown Resorts ((CWN)), Fairfax Media ((FXJ)), Mirvac Group ((MGR)), Tabcorp ((TAH)) and the biggie, Telstra ((TLS)).
 

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