Weekly Market Update: A Yuan Way Market
China's currency devaluation upset global markets this week. While the IMF and a few others applauded the move, many analysts quickly diagnosed the devaluation as yet another panicky attempt by Beijing to stimulate China's slowing economy. Emerging market currencies and commodity prices, already suffering from China's troubles, were hit hard by the devaluation. In Europe, preliminary second-quarter GDP data was weaker than expected, taking some of the shine off the slow-motion recovery seen in many other economic data points out recently. Low inflation woes continued as WTI crude oil hit a new six-year low below $42/bbl. US markets saw sluggish, low-volume summer trading, though the worst damage from the devaluation passed quickly, allowing stocks to finish the week modestly higher, with DJIA gaining 0.6%, the S&P up 0.7%, and the Nasdaq 0.1% higher.
For years, China has taken heat (mostly from the US) for keeping its currency artificially low to aid its export-driven economy. Since 2005, Beijing has let the yuan appreciate by 30% against the dollar, thanks to external pressure as well as a real desire to liberalize the yuan and see it become a major reserve currency. Back in May, the IMF declared that the yuan was no longer undervalued, although they also urged Chinese leaders to take more steps toward a free-floating currency. This week they got more of what they wanted: the PBoC's daily yuan fixing on Tuesday set USD/CNY at 6.2298, 1.9% higher than the prior 6.1162 fixing, the biggest move up on record. This was followed by two consecutive 1.6% devaluations, for a total devaluation of approximately 5% over three days (note the yuan appreciated 0.5% in Friday's fixing). The move was clearly aimed at helping flagging Chinese growth by boosting exports, though the PBoC framed the move as an effort at greater liberalization, saying that the action was "rooted in analysis of economic data" and that moving forward the fixing would take into account the positions of market makers at day's end.
Headlines screamed that China's devaluation had opened a new front in the currency wars. The policy tightening drumbeat out of the Fed had already begun the stampede of capital out of emerging markets, and Beijing's new FX policy put more hurt on delicate FX crosses. The ruble dropped to six-month lows against the dollar, South Africa's Rand hit 14-year lows against the dollar and the Malaysian Ringgit plumbed a fresh 17-year low. South Korean authorities were said to have sold up to $4 billion to slow the decline of the won, while Mexico Central Bank Governor Carstens warned that interest rates could be raised at any time to defend the peso, which is at record lows. MSCI's emerging equity index fell to four-year lows. The AUD has already suffered mightily from China's slowdown, and AUD/USD touched a fresh six-year low around 0.7240 on Wednesday before ending the week back around 0.7400. EUR/USD remains squarely in the middle of the range it has traded in since May; the pair gained two and a half big figures, from 1.0966 to 1.1214 Monday to Wednesday.
It's only a month until the September FOMC meeting and the consensus was that Beijing's excellent FX adventure would not significantly impact the Fed's thinking on interest rates. Early in the week, Fed moderate Lockhart said he was very disposed to a possible September liftoff, with July payrolls satisfactory and shorter-term inflation figures firming up. Fed dove Dudley said rates could hopefully be raised "in the near future." Dudley also said the Fed will closely watch developments in the Chinese economy and warned what happens with the yuan has huge implications for global demand. In a widely read note, JPMorgan warned that the firm continues to view short-term yields as underestimating both the timing and pace of the coming Fed rate hikes.
The June JOLTS report - Fed Chair Yellen's favorite gauge of labor market health - showed job openings were slightly fewer than expected, while the hiring rate rose to a YTD high of 3.7%. Other details in the survey stayed relatively unchanged for the month, with the quits rate steady at 1.9%. Despite the narrow miss, job openings are up more than 11% y/y. The US July retail sales report indicated the US consumer continues to boost spending, with the headline figure +0.6%, in line with expectations. The June ex auto, ex auto and gas, and control group components were revised up to modest growth from small declines, however the headline June retail sales were left at -0.3%.
Greece wrapped up talks with its European creditors on the details of its €86B third bailout package this week and the Greek parliament approved the agreement. The package includes €85.5B in aid and anticipates €6.2B in privatization revenues. The IMF is still not an official participant, but the Germans indicated that providing certain conditions are met, it is prepared to get onboard again, possibly as soon as November. Doubts remain about Greece's debt sustainability, and skeptical press reports indicated some officials feel the bailout isn't big enough. As the EU kept up pressure on Germany to offer some form of debt relief, Berlin reiterated its mantra that debt haircuts were not and would not be part of the deal. An EU debt sustainability analysis found that even with better-than-expected implementation of reforms, Greece's debt would stand at a relatively unsustainable 148% of GDP in 2022. Partial implementation would put Greek debt to GDP at 174% in 2022.
Google rolled out a new holding company organizational structure on Monday. Management will place Google's sprawling family of operating units under Alphabet, which will replace Google as the publicly-traded entity. Google will become a wholly-owned subsidiary of Alphabet. Basically, the company breaks its financial performance into two baskets: Google (with its lucrative search and ads business, YouTube and Android) and everything else, including Nest home automation, Google Fiber, Google X, Calico and Google Capital.
Shares of Chinese ecommerce giant Alibaba sank a little further this week after a disappointing second-quarter earnings report, with BABA closing out the week around $75, not far from its November 2014 IPO price of $68. Alibaba only just met expectations in the quarter. The firm's revenue grew 28% y/y in the quarter, which was not enough to meet investors' heightened expectations, and the currency chaos in China hardly helped. In other earnings, department stores Macy's and Kohl's lost ground after both firms missed top- and bottom-line expectations it second-quarter reports. JC Penny saw good gains on a solid report. Cisco's growing software sales revenue suggested the firm continues to make progress in its effort to reorient to cloud services from hardware sales.
Berkshire Hathaway reached a deal to buy Precision Castparts in a $37.2 billion deal, in a transaction valued at $235 per share in cash - a 21% premium to the stock's closing price on Friday. Precision Castparts manufactures some of the metal components that go into aircraft engines and industrial gas turbines. After announcing the deal, Warren Buffett said he was "done hunting elephants," closing out his hunt for a jumbo acquisition that began back in 2011. In addition, Buffett poured cold water on the idea that Berkshire's Heinz would consider buying Mondelez. Just last week, activist Bill Ackman's Pershing Square took a 7.5% stake in Mondelez and encouraged the board to begin looking for a buyer.