Surprise Chinese currency devaluation rattles markets

The Chinese authorities allowed their exchange rate to depreciate around 4.5% in August as part of a plan to move towards a more market-determined rate. This has generally been viewed as a positive development.

However, the move may have been broadly interpreted by investors as a sign of more serious economic issues surrounding the slowing Chinese economy. This caused a plunge in the Chinese share market leaving some market commentators to argue that the sell-down in China was overdone and not supported by any broad weakness in the country’s economy.

Recent economic data from China points to a contraction in manufacturing activity for six months in a row. However, retail sales were better than expected and new house prices continue to improve as the Chinese regulators provide stimulus, such as the recent lowering of the down payment requirement for first mortgages from 30% to 25% in most cities.

Emerging markets suffer brunt of recent market volatility

Concerns following the recent devaluation of the Chinese currency also sparked a fierce sell-off across emerging markets. The MSCI Emerging Market Index, which represents shares from over 20 emerging market countries (including China, Brazil, India and South Africa) returned -18.5% in the September quarter.

Australian share market not spared

The Australian share market (represented by S&P/ASX 300 Accumulation Index) was not spared with its reliance on commodity exports to China. The price of iron ore, Australia’s largest mineral export, is currently US$57 per tonne down from US$105 mid last year. The Australian share market index slumped to another negative quarter with a return of -6.5% in September adding to June quarter’s loss of -6.5%. The cumulative loss over the last two quarters was the largest in four years.

In light of current events, the Reserve Bank of Australia’s (RBA) decision to leave the cash rate at 2.00% since May this year should sustain our moderately expanding economy which is still adjusting to a decline in mining investment that peaked at 8% of Gross Domestic Product (GDP) in late 2012.

Share markets of developed economies relatively more resilient

The overseas share market (represented by MSCI World ex Australia Index, unhedged in Australian dollars), valued in foreign currencies, has resiliently returned +0.4% over the September quarter and +18.9% over the last 12 months. The performance of overseas shares in Australian dollar terms was predominantly driven by the -20% fall of the Australian dollar to $0.70 against the US dollar in the last 12 months.

Listed US and European companies which comprise over half of the overseas share market were resilient overall on the back of the favourable global financial conditions. An improving US economy remains to be supported by low interest rates and other major central banks’ continued easing of their monetary policies to support their economic recovery.

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