On Tuesday the PBoC devalued the RMB by 1.86%, its biggest devaluation since 1994. It also announced a deregulation of the currency regime that will allow the PBoC significantly to reduce intervention.
I expect that the PBoC will have to choose between intervening to nearly the same extent as it had in the past and allowing the RMB to depreciate a lot more than it has, perhaps 10% or more.
There are two very important risks that I will be watching for. The first is that this move is perceived as being an aggressive first step in a new round of trade wars, with other countries in Asia especially quick to take umbrage and to retaliate. Although I think it is hard to justify criticism of the new currency regime on those grounds, I also expect trade tensions to continue rising and the global trade environment to continue deteriorating anyway, so accusations will be plentiful.
The second great risk is further erosion in credibility, leading to increased capital outflows. It is far too early to say, but this risk is somewhat counterbalanced by an improvement in credibility that reduces outflow. We will have to wait and see.
Finally everything has occurred so quickly that this newsletter was written in record time. Please therefore excuse typos and garbled thinking.
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