What Yuan? Currency Near Low With S&P 500 at High Is a First

  • Weaker currency presaged last two stock market selloffs
  • Bulls argue sliding yuan under control by Chinese government

An ability to whistle past trouble has marked the progress of U.S. stocks for seven years. But getting to records while staring at a threat that had investors whimpering just four months ago is something new.

Whatever became of the falling yuan, celebrated villain of American equity corrections in January and August? Devaluation of the Chinese currency was supposed to foretell the end of liquidity, a world whose main engine of growth was seizing up, tolling the bell for risk-on euphoria.

Except now it doesn’t matter.

The yuan has swooned 3.3 percent since reaching its 2016 high of 6.45 per dollar in March, on pace with the drop it took in the months leading up to the 11 percent selloff in the S&P 500 Index at the start of the year. This time it happened as the benchmark gauge for U.S. stocks rallied 8.6 percent to records after the U.K.’s vote to leave the European Union and amid speculation the Federal Reserve will hold rates steady this year.

Since the start of the bull market, there hasn’t been another time the S&P 500 got to highs amid a depreciation of more than 3 percent in the yuan in the prior three months.

“The unexpected effect of Brexit is the central bank-driven rally that is overriding concerns about things like China,” Peter Cecchini, the New York-based co-head of equities and chief market strategist at Cantor Fitzgerald, said by phone. “The currency and stocks corresponded this year and in August, and I think there was a causal connection. The question is why it might not be on people’s minds now.”

Chinese economic health was at the center of equity market turmoil last summer as investors assessed slowing global growth and a shock devaluation by China’s central bank in August. The same investors were flattened anew at the start of the year as the S&P 500 dropped 11 percent amid concerns over monetary policy, declining corporate earnings and global growth weighed on sentiment.

Losses in the yuan haven’t abated since then. The currency’s drop next to the U.S. dollar since March 31 included a 1.7 percent drop in May, its worst monthly loss since August. That compares to a two-day slide of 2.8 percent on August 11-12 and a 4 percent drop from then through January.

The dollar has rallied 3.6 percent against a Bloomberg basket of 10 leading global currencies since a May low. That, combined with weakness in the Chinese economy, has hurt the country’s currency, according to Bloomberg Intelligence Chief Economist Michael McDonough. He says the absence of a market panic similar to that of previous periods of devaluation doesn’t mean investors are in the clear.

“That Goldilocks scenario for Beijing reflects a combination of factors, including reduced fears of an imminent hard landing, improved communication and stability in China’s asset markets,” wrote McDonough, who is also global director of economic research. “Nevertheless, as the gap between policy makers’ verbal assurances of stability and the reality of creeping depreciation grows, the risks of another downward spiral are ever present.”

One possibility is that China’s improved communication with markets and steps to prevent a downward spiral of depreciation and capital outflows have allayed investor anxiety. HSBC Holdings Plc sees little chance of a return to January’s turmoil, while Beijing Gao Hua Securities Co. says the yuan will be stronger against a basket of trading partners’ currencies by the end of the year.

There’s also the explanation that rallying stocks may not be a verdict on China’s economy at all. In addition to navigating a fifth straight quarterly decline in corporate earnings, money managers in 2016 have been faced with a handful of geopolitical surprises that have captured the market’s attention, from England’s Brexit to an attempted military coup in Turkey.

“Everything going on politically, both domestic and global, has put everything going on in China kind of in the background,” Michael O’Rourke, chief market strategist at Jonestrading Institutional Services LLC, said by phone. “There’s a lot of apathy about the market, people have been waiting for a correction, but the new highs forced them to step in and reallocate their funds.”

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