Reputed to be an ancient Chinese curse, “interesting” in the above phrase was meant to signify dangerous or turbulent times. Fingers were pointing at China last week as being responsible for market volatility due to the significant fall in the Chinese equity market and surprise devaluation of the Renminbi. We’ll leave comment on the equity market to our Emerging Market colleagues, but we will make two points on the currency. Firstly, we’ve seen a 3% devaluation so far, and 1-year forward rates are suggesting another 5% within 12 months. But the market is likely to press for a more significant devaluation than 5%, so the reaction of the Chinese authorities will be interesting. Secondly, we understand that the Chinese authorities have been intervening to stabilise the currency to the tune of about US$10bn a day. That intervention is financed by liquidating FX reserves, most of which are invested in bonds. Should intervention continue, we may see the People’s Bank of China becoming a forced seller of bonds, putting upward pressure on G-7 investment grade bond yields. Asian central banks have long been fans of French government bonds, seeing them as a higher-yielding proxy for German Bunds. It will be interesting to watch the spread between French and German government bonds in coming weeks.
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