beyondbrics

Investors in equity markets generally welcomed China’s currency policy announcement bidding shares in the hope that the move could ease global economic tensions and boost growth.

But the gains were tempered by concerns that Beijing’s pledge of increased flexibility in currency management would not produce any immediate dramatic appreciation of the renminbi, limiting the economic benefits and possibly provoking a hostile reaction in the US, China’s principal economic partner.

“Beijing’s attempt to throw sand in the eyes of the world with its announcement of increased yuan flexibility is set to backfire, ” warns Lombard Street Research in a particularly blunt assessment. Lombard Street said in a note today:

Minimal yuan appreciation is unlikely to be acceptable when the US recovery peters out later this year, while Europe heads for a recession. It will also mean a sharper domestic correction in overheating China.

Unless there is a fundamental change in China’s mode of development, it will be difficult to see the world not slipping into increased protectionism and every country/region having to fend for itself.

Capital Economics is less apocalyptic but still cautious about the long-term effects of the weekend’s announcement. It said in a note yesterday that initial reactions would be positive with equities gaining on hopes of economic stability and the easing of trade tensions, and the US dollar declining against the euro and the yen as the flight to dollar safety slows. But the long-term effects will be limited. Capital Economics says:

We do not expect these initial responses to be sustained. For a start, the subsequent appreciation of the renminbi against the dollar is likely to be small, perhaps just a few percent over the remainder of the year. This is not a game-changer and trade tensions will soon return. What’s more, even a much bigger move would do nothing to boost the global economy without additional steps to increase demand within China itself.

Any sell-off in Treasuries should also be short-lived. The fundamentals for US government bonds remain positive regardless of China’s currency policy. But as it happens, Beijing might even have to step up purchases of overseas assets to offset increased inflows of hot money into China in anticipation of further currency gains. Elsewhere, the evolution of the European fiscal crisis is a far more important (and still negative) factor for the euro, while the key driver of UK markets will be Tuesday’s Budget. Overall, lots of dramatic headlines, but how much has really changed?

UBS focuses more on the short-term benefits to equities saying it lifts earnings for HK$-based companies, lowers the risks of a trade war, and cools an overheated Chinese economy. “A multi-year appreciation would also lift the earnings growth profile [of offshore lsited companies].”

But, says UBS, “a multi-year appreciation would force investors to focus on the negatives such as weaker exports, rising unemployment and a capital spill-over into China”.

Companies which benefit the most are those with Rmb sales and US$ costs, or Rmb assets and US$ liabilities, and vice versa, says UBS. We believe the airlines, paper, steel, petrochemical, telecom, LCD TV production, food processing and consumer staples industries should benefit more than the market, plus real estate. UBS’s picks include Air China, Sinopec; Angang Steel, Hengan International and Agile.

In the markets today, the bulls prevailed over the bears. The Shanghai Composite finished up 2.9 per cent and the Nikkei 225 2.43 per cent higher. The Hang Seng was up 3.03 per cent in late trading. The MSCI Emerging Markets Index gained 2.54 percent to 977.64 as of 0925 BST.

“Stocks in the region are moving on anticipation that the removal of the peg will be positive,” Eduardo Banaag, of First Metro Investment Corp, told Bloomberg. “Global markets, not only Asia, will simply follow. The removal of the peg is a positive development.”

Related reading:
Renminbi unmoved, but other Asian currencies taking flight, FT beyondbrics