The People’s Bank of China (PBOC) surprised currency markets last week when it devalued the renminbi by 1.9%. The PBOC indicated the devaluation would be a one-off but in the offshore currency markets, where the renminbi is floating, the currency slid. Markets feared the devaluation was an indication the Chinese government thought the economy was might be doing worse than what was currently expected. Global equity markets reacted by falling and bond market measures of risk spiked higher. iTraxx, which measures the cost of credit default swap contracts, rose by 1.5% on the day of the announcement and another 3% the next day, while safe-haven bond yields dropped by unusually large daily amounts.
Prior to a string of weaker economic indicators results, China’s policy was to move the composition of economic growth away from investment and towards consumption. China’s move created uncertainty with regards to the continuation of the policy and some market participants saw the devaluation as a possible reversal of this policy, at least in the short term.
Calm returned but only after a sustained campaign by Chinese officials who said a further fall in the exchange rate was unnecessary. The PBOC said China’s strong economic environment, sustained trade surplus, sound fiscal position and deep foreign exchange reserves provided “strong support” for the exchange rate.
