On Tuesday, Chinese central bank shocked the global financial world by devaluing its currency against the dollar. The move, devalued the Chinese currency to its lowest level since 2010 in a move aimed at reviving the Chinese economy which has faced reduced income from export in the past few months. After the news, major global currencies reacted with many people making some nasty losses. The Chinese yen had the biggest single-day drop since 1994 in a move that the Central Bank called a one-time adjustment. The yuan settled at 6.3231 against the dollar which represented a 1.8% drop in Shanghai.
The impact of the devaluation was not a yuan/dollar alone impact. Major currencies such as New Zealand dollar, Australian dollar, and the pound all fell against the yuan. In addition, the Dow, NASDAQ, and S&P all fell by significant margins on Tuesday. In Europe, markets reacted by going south with fears that the weakening Chinese economy could have serious implications in trade. In the United Kingdom, the benchmark FTSE 100 index fell sharply by 1.8% to 6544.20. In France, the CAC fell by 1.7%. In Germany and Spain, the DAX and the IBEX fell by 2% and 1.5% respectively. In commodities, all the major commodities except the precious metals fell with many analysts estimating reduced buying demand from the Chinese market. In addition, a number of companies with key interest in the Chinese market fell too. Some of them are Anglo American, Glencore, and the major airline stocks.
China is the second largest economy in the world after the United States. It is also the world’s biggest consumer of major products such as metal, clothes, and food products.
In the recent past, the country has experienced a weak economic growth. The Shanghai composite index, which represents most of the Chinese actively traded companies has fallen by more than 14% leading to measures limiting trading and IPO in the market. In addition, the country has undergone a period of slowing exports and increasing (and expensive imports), reduced job creation rate, cheaper gas, and falling stock market. Many experts believe the devaluation was intended to salvage the falling economic data.
Other analysts believe that the Chinese government intention is to make the currency influential in the financial market. In April, in a move to strengthen the yuan, the central bank bought yuan in the financial market and sold their US dollar holdings in a move that was aimed at stemming capital outflows from China.
In fact, a number of experts believe that the devaluation’s intention was aimed at the imminent interest rate hike by the Federal Open Market Commission (FOMC). As the dollar rises against the other major global currencies, the yuan also rises against them. This shows the close relationship between the two currencies.
How to trade the uncertain times
As the Chinese economy undergoes uncertainties and the ultimate volatility, day traders need to be very careful. At these times, having a broader outlook, rather than focusing on the technical indicators will help you. For instance, no one had predicted the massive devaluation on Tuesday and the follow-up on Wednesday. Therefore, since the technical indicators focus on the chart patterns, the fact is that in this situation, the fundamentalists had their day.
In currencies, I believe that the dollar will continue to strengthen in the next month before the fed meeting in September. However, going by the recent released data, my feeling is that the American economy is not stable for a rate hike. On Tuesday, the QoQ Nonfarm productivity numbers and the API weekly crude oil stock fell short of what analysts had forecasted. On Wednesday, the federal budget balance also fell short of analysts expectations. The recent labor and inflation numbers have also not lived to the expectations of the analysts. For this reason, I anticipate that a rate hike might come later in the year or early next year.
For commodity traders, the rate hike will lead to increased costs of owning these commodities. As a result, their prices will go down with reduced demand. Crude oil prices have in the last 3 weeks taken a nose dive and with the Iran deal almost closing, there will be increased production leading to oil glut. Therefore, oil prices will ultimately go down which favour a short term short position on crude.
In conclusion, day traders need to be very careful when allocating capital especially in a time when the Chinese economy is uncertain. No one knows what the Chinese government is planning. Therefore, you should allocate resources after doing due diligence and considering having a stop loss to prevent shock losses.