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Market Sentiment Deteriorates Following China’s Currency Devaluation

Market Sentiment Deteriorates Following China's Currency Devaluation by OFR

Risk aversion intensified in August following China’s surprise renminbi (RMB) devaluation and its shift toward a more market-oriented currency regime. Uncertainty remains about the implementation of the new framework. The currency moves magnified market concerns about slowing global growth and inflation, causing pronounced sell-offs in markets for commodities, emerging market currencies, and global equities.

Recent developments:

  • China devalued its currency and announced plans to establish a more market-based currency regime.
  • Commodity prices, global equities, and emerging market currencies came under significant pressure on concerns that a weakening Chinese economy could diminish global growth.
  • The growth concerns and market turbulence have reduced expectations for the Federal Reserve to begin raising interest rates in coming months. The market-implied probability of a rate hike in 2015 is now about 50 percent.
  • Puerto Rico’s Public Finance Corporation defaulted on an August debt payment, but with little spillover to broader municipal debt markets.
  • Market concerns about Greece receded as its government reached an agreement with other euro area governments for a new financial support program.

China devalued its currency and continued policies to stem equity market declines.

China’s central bank unexpectedly announced a significant change to its foreign exchange policy. The authorities weakened the fixing rate used to determine the daily dollar-renminbi exchange rate and implemented a new mechanism for setting the rate. Citing a desire to close the gap...