BofA Says Sharp Yuan Devaluation Will Lower Commodity Prices

  • Every 1% drop in currency leads to 0.6% loss in raw materials
  • Worsening domestic demand may lead to cheaper yuan, BofA says

A depreciation of 1 percent in the Chinese yuan leads to a decline of 0.6 percent in commodity prices, according to Bank of America Corp.

This relationship with the currency is the strongest for commodities such as copper and platinum, of which China is the world’s dominant consumer, the U.S. bank’s strategists wrote in a report dated Jan. 25. A cheaper yuan will erode the purchasing power of the Chinese, pushing prices down and outweighing any benefit from easier financial conditions that a devaluation may bring, they said. 

Bank of America analysts compared the moves on the Bloomberg Commodity Index with the yuan’s changes against the dollar and a basket of other currencies to calculate the so-called beta, which measures one security’s sensitivity to another. The chart below partially recreates their findings, with the red line showing how much commodity prices plotted on the Y axis move for a given change in yuan rates on the X axis.

“A sharp yuan devaluation, which is not currently our base case, could come as a result of worsening domestic demand,” Francisco Blanch, head of commodities research at Bank of America’s Merrill Lynch unit, said in the report. It “would certainly be a lot more disruptive to commodity markets.”

The probability of further depreciation in the Chinese currency is high, according to Per Hammarlund, the chief emerging-market strategist at SEB AB.

“The People’s Bank of China has essentially pegged the yuan to the dollar since Jan. 7,” Hammarlund said by e-mail from Stockholm. “However, capital continues to flow out of the country and that will prompt the central bank to allow the currency to depreciate once the market turbulence has settled.”

That will put pressure on commodity prices, hurting exporting nations, while causing a “large windfall” in terms of lower import bills for countries like Turkey, he said.

“Right now, there are no indications that the correlation between a weaker yuan and lower commodity prices will break,” he said.

The onshore yuan retreated 0.03 percent against the dollar on Monday to 6.5783 in Shanghai.

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