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Markets perform better as China moves up yuan, suspends circuit breaker

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Jan 8, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Mumbai) - The circuit breaker mechanism which was introduced by China four days ago on the backdrop of a 7 per cent slide in stock markets on Monday has been suspended. In the first place, they were introduced to calm markets and soothe nerves of jittery investors.

    However, the measure instead of reassuring markets caused investors to panic that they will be restricted from selling shares they want to get rid of. The introduction of the circuit breaker mechanism forced markets to conclude that Beijing was trying to avoid an inevitable market crash. Thus, the mechanism sparked more volatility and panic given that investors always find it beneficial to yank shares just selloff sets in.
    Unfortunately for China the consequence completely contrasted its interests. To make matters worse, the authorities had to bear criticism from all quarters for their lack of communication and their desperate attempt to control price fall.

    The circuit breaker was brought in on the very first trading day of 2016 to prevent free falling of stock prices. Once again the mechanism was brought into play within half an hour of trading yesterday, marking the shortest trading day in China in 25 years. Suspension of shares in China caused global shares to fall sharply on Thursday, with Wall Street opening more than 1% lower and European markets trading 2% down.

    China Securities Regulatory Commission (CSRC) in a statement reasoned "After weighing advantages and disadvantages, currently the negative effect is bigger than the positive one. Therefore, in order to maintain market stability, CSRC has decided to suspend the circuit-breaker mechanism”.

    Investor sentiment was left battered further when the PBoC guided the yuan lower first on Tuesday and then again yesterday. Yuan’s devaluation yesterday meant to boost Chinese exports, sparked fears of currency war as it was obvious that China’s move to guide its currency lower would pressurize other Asian countries particularly China’s trading partners to devalue their currencies in order to remain competitive. This would lead to an increase in volatility in markets.

    Also, it signalled that consumer demands in China will likely slowdown more sharply than expected. This means a weaker yuan will hinder China’s transition from an export-led one to a consumer and services-led growth model. To add to the pressure, investors disturbed by continuous yuan devaluation will choose to remove capital from China and park it at overseas market, leading to severe capital crunch. China is no position to stomach more fall in foreign reserves.

    Considering the adverse consequences, the PBoC today set the yuan reference rate at 6.5636 against the dollar, which is an increase of 0.02 per cent from yesterday's fix and also higher than the yuan's yesterday’s closing rate of 6.5929 in onshore trading. With today’s fix, the PBoC for the first time in nine days set the yuan reference rate higher. The PBOC's decision to set yuan target higher is "a signal it does not intend to keep allowing the yuan to fall," according to Yoshinori Shigemi, global market strategist at JPMorgan Asset Management.

    Impact on the market

    Asian shares rebounded today on the news of circuit breaker suspension and higher yuan. Chinese equities rose more than 2 per cent. The CSI300 index .CSI300 was up 2.7 per cent and the Shanghai Composite .SSEC rose 2.4 per cent. The spot market opened at 6.5700 per dollar, and was noted to be trading at 6.5887 at 0313 GMT.

    After the higher fix, the yuan rose to 6.5885 in onshore trading today. Offshore yuan also climbed to 6.6799 against the dollar after having plunged to 6.7511 yesterday. Mitul Kotecha, head of Asian interest rate and foreign exchange strategy at Barclays is of the opinion that "The PBOC is trying to instill two-way risks in the yuan as it doesn't want investors to get carried away on speculation that the currency will continue to slide”.
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