The financial carnage at the start of the year was the worst of its kind for many markets.
It saw the US S&P 500 fall 6%, which was the worst first five trading days in history. Chinese stocks plunged 10%, triggering newly-installed circuit breakers which halted trading at crucial moments.
This week started in similar fashion, with Chinese equities plunging again by 5%. But US stocks didn’t follow them down this time.
Here’s the chart from Bank of America Merrill Lynch:
There’s a good reason for US stocks uncoupling from Chinese stocks, and indeed they might not have been following them in the first place, rather China’s currency instead.
Here’s Bank of America analyst Hans Mikkelsen with a neat summing up (emphasis and bullet points ours):
- Recall that last week the PBOC allowed their currency to depreciate more than 1.5%, a pace much faster than we have seen since August last year.
- Within the mix of policy changes in response to what transpired last week — including the removal of circuit breakers in the Chinese equity market, etc. — it is very clear that the PBOC is now working to stabilise the Renminbi.
- We saw this first on Friday where for the first time this year the PBOC set the Renminbi fix at roughly unchanged levels.
- This repeated today for the second consecutive day, prompting a 0.36% rally in the Renminbi spot against the USD. Hence the stability in US equities as fears of global deflationary developments declined.
The reasoning behind this is that if China lets its currency depreciate quickly, it will cause Chinese exports to fall in price. With the dollar strengthening against it, US companies would find it harder to compete on price and so cut profit targets, leading to lower share prices.
One of the grander fears is that, with oil falling in price at the same time, cheaper Chinese goods could send a wave of deflation across the world, sparking a recession as people hold off on purchases.
But that scenario might not play out because it seems like Chinese policymakers are determined to stabilise their currency, which global stocks might not follow Chinese equities if and when they crash.
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