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After The Chinese Devaluation, Who's Next?

Via Credit Agricole's Valentin Marenov,

In a surprise move overnight, the PBOC devalued the CNY by most on record, sending Asia G10 and EM currencies lower.

The selloff seems driven by concerns that the FX boost to the Chinese international competitiveness would affect other manufacturing exporters while pricier commodities could dampen Chinese demand for Australian and NZ exports.

 

On a broader level, the devaluation signals PBOC’s eagerness to join the global currency wars. With the competitive devaluation by various central banks gaining momentum but global trade slowing, the latest CNY devaluation could be seen as likely to force other central banks to consider similar measures before long. Yet another consideration here should be the impact of the PBOC actions on the capital outflows from China.

If the outflows were to intensify after the CNY tumble, the erosion of central bank’s FX reserves should continue and add to concerns about insufficient future sovereign demand for global assets. In turn this should continue to boost risk premia in the global bond and stock markets.

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One currency that so far has successfully weathered the storm has been JPY.

We doubt that JPY could decouple from the selloff in Asia FX for too long, however. The CNY devaluation comes on the back of disappointing trade data out of China (Japan’s main trading partner) and highlights that the external conditions for Japanese exporters could deteriorate further.

 

All this adds to the list of BoJ’s worries that already includes the stubbornly low Japanese inflation and casts doubt over the bank’s ability to achieve its 2% target anytime soon.

 

Against this background, potential disappointments from the Japanese machine orders release today and industrial production data tomorrow could extend the BoJ’s list of concerns with investors anxiously anticipating the Q2 GDP release next week.

While recent communication from Governor Kuroda did not seem to signal any desire for an imminent change in policy, we believe that the time the BoJ announces yet another QE is drawing near.

We subsequently see risks for USD/JPY on the upside from here.