Global Markets

Traders were jolted out of their mid-summer reverie when the People's Bank of China devalued its currency the renminbi (yuan) on Tuesday. The move dominated markets globally for the week, sending (most) equities tumbling along with emerging market countries' currencies. Most equity indexes retreated on the week, the exception being the Shanghai Composite which was up 5.9 percent. It was a relatively light week for new economic information and earnings season continued to wind down.

The renminbi (yuan)

On Thursday and for the third day in a row, the People's Bank of China devalued the renminbi (yuan), this time by 1.1 percent against the dollar. The total devaluation between Tuesday and Thursday was 4.4 percent, the biggest drop in decades. Government officials, in an unexpected news conference on Thursday, stressed that the currency was not in free fall. Global markets appeared to respond to the assurances. The devaluation reflects weakness in the Chinese economy — a weaker currency would make goods more affordable for overseas buyers — but at the same time it risks tensions with its trading partners.

It is helpful to understand how the PBoC sets the value of the yuan. Each morning market makers such as the big state-owned banks submit yuan-U.S. dollar prices to the PBoC which then averages these to calculate a "central parity" rate, or midpoint. Over the course of the day, the PBoC intervenes to keep the exchange rate from straying more than 2 percent above or below the midpoint. In theory, it is the market makers — not the central bank — which set the midpoint and thus the trading band. In practice, the PBoC gets market makers to submit rates that will yield its preferred midpoint, irrespective of market sentiment.

The reform the PBoC announced on August 11th sought to change this. From now on, the PBoC said that the midpoint would simply be the previous day's closing value. Given that traders had been selling and buying yuan at a big discount to the manipulated midpoint, the new market determined midpoint immediately fell by 1.9 percent, the biggest single day drop in the currency's modern history.

That led to an even weaker market determined midpoint on August 12^th. The yuan fell yet again, sparking fears that the currency might be on the brink of a rout. But it was at this point that the central bank intervened. It ordered state-owned banks to sell dollars and buy yuan, propping up the exchange rate at the very time that it was being accused of devaluing it. This tug-of-war could play out for some time, with traders repeatedly testing the limits of the PBoC's tolerance for depreciation. It should be noted that the PBoC set the mid-point slightly higher on Friday, easing tensions before the weekend.

Previously when China's economy swooned, its currency held steady or strengthened — even as China's neighbors or trading partners scrambled to cut the value of their own currencies to deal with the fallout. With the Chinese renminbi now taking its biggest plunge in decades, the worry is that the country's already slowing economy is even worse off than reported and that the government is panicking. Previously, the government took the usual steps of cutting interest rates and freeing up more money for banks to lend. But the leadership has also turned to more unconventional means in recent months to try to cushion the blow as the economy's once-runaway expansion sinks back to earth.

Global Stock Market Recap

Europe and the UK

Equities declined last week. The FTSE lost 2.5 percent, the CAC retreated 3.8 percent, the DAX dropped 4.5 percent and the SMI was down a relatively mild 0.7 percent. The indexes were hit by the surprise drop in the yuan which in turn hit major exporters to China very hard. Europe's stock indexes plummeted Wednesday after China's central bank allowed the tightly controlled yuan to slide for a second day, raising more concerns about the health of the country's economy. The move in the yuan has hit European companies who rely on Chinese demand for their products particularly hard. An ameliorating event to some degree was the approval by the Greek Parliament of the country's latest bailout package.

Finance ministers from the Eurozone met in Brussels on Friday and as expected gave their final blessing to lending Greece up to €85.5 billion after the parliament in Athens agreed to stiff conditions overnight. However, some issues still need to be ironed out following a deal struck with Greece on Tuesday by the European Commission, European Central Bank and International Monetary Fund. Among these are how to deliver some €25 billion in new capital to Greek banks and keeping the IMF involved in overseeing the new Eurozone program while at the same time satisfying IMF calls for debt relief for Greece until a review in October.

Some pressure was taken off Greece Thursday. The European Central Bank said it was increasing its emergency lending to the country's banks. Eurozone finance ministers granted "in principle" a bailout from the bloc's fund after Greece's Parliament approved austerity measures. However, several top decision makers expressed reservations about whether Athens could see through its promised overhauls.

Friday's second quarter growth was a sobering event. The Eurozone's modest economic recovery suffered a setback in the second quarter as France stagnated and Germany posted a tepid expansion, underscoring the deep-rooted fragility in the region. The data came amid heightened concerns in financial markets about China's economy, which has been an engine of growth for global activity over the past decade. The results put greater pressure on the U.S. to generate output for both itself and its trading partners, and suggests the European Central Bank will keep its aggressive stimulus measures in place at least through next autumn as planned.

Gross domestic product growth in the eurozone slowed to 0.3 percent from 0.4 percent in the first quarter, falling short of forecasts of a 0.4 percent gain. Although Germany's quarterly growth rate quickened to 0.4 percent from 0.3 percent in the first, it fell short of forecasts of 0.5 percent growth. Output in France stagnated after a strong jump in the first three months of the year. The Italian and Dutch economies grew, but just barely.

Of particular concern is that Eurozone output has weakened at a time when the region is benefitting from the massive stimulus of a weaker euro exchange rate that typically boosts exports, lower oil prices that raise disposable incomes and a bond buying program of more than €1 trillion launched by the ECB in March. Growth remains insufficient to boost inflation — the harmonized index of consumer prices was up just 0.2 percent on the year in July and was far below the ECB's target of just under 1 percent.

Asia Pacific

Equities were down last week — that is all but the Shanghai Composite. It added 5.9 percent on the week. Malaysia's KLCI and Indonesia's Jakarta Composite sank 5.1 percent and 3.9 percent respectively as emerging countries in the region suffered the most from the yuan's depreciation. Markets stabilized Friday with some regional currencies rebounding as China's yuan was slightly stronger after its steep devaluation earlier in the week. Still, China's devaluation starting Tuesday has left many Asian markets battered for the week amid worries about increased competition from a cheaper yuan. The move dealt an additional blow to economies reliant on exporting commodities given heightened fears of China's slowing demand.

The Shanghai Composite held its ground despite the currency's upheaval. At a press conference held Thursday in Beijing, the People's Bank of China said that the currency would strengthen again and there was no basis for continued depreciation in the yuan. While pledging to improve the yuan's pricing mechanism, central bank officials dismissed speculation of a possible yuan drop of 10 percent as "groundless". The soothing comments by authorities coupled with a rebound in commodity prices and speculation that Federal Reserve officials may delay raising rates drove investors towards equities once again, reducing the appeal of perceived safe-demand assets.

Currencies

The U.S. dollar was pummeled last week — it was down against all of its major counterparts including the euro, yen, pound, Swiss franc and the Canadian dollar. However, it was up against the Australian dollar and of course, the yuan. The Australian dollar retreated as investors bet that a weaker yuan means slowing exports to China. China is Australia's largest trading partner. Emerging country currencies including Malaysia's ringgit for example, plunged to a fresh 17-year low of 4.150 in intraday trading against the U.S. dollar Friday and lost 3.8 percent on the week. Investors worry a weaker yuan will hit China's imports of Malaysia's oil, when the nation is already facing lower revenues from a commodities rout and the prospect of political instability given an investigation into its troubled state investment fund.

On Friday, fears about a rapid yuan devaluation subsided after the People's Bank of China set the currency's daily reference point a tad higher from the previous day's midpoint. The move comes a day after the central bank said there was no basis for continued currency depreciation. There are fears that other countries that rely on exports to China will seek to devalue their currencies to compete in a world of slower growth. While Vietnam widened the dong's trading band to allow the currency to weaken, Indonesia's rupiah and Malaysia's ringgit hit 17-year lows. China's yuan hit a four-year low, pushing the dollar higher and heightening concerns about a global currency war.

Selected currencies — weekly results

Indicator scoreboard

Eurozone

Eurozone growth slowed in the second quarter with Germany, France and Italy all expanding slightly less than anticipated. Eurozone GDP was up 0.3 percent in the April-June quarter, down from 0.4 percent in the two previous quarters and less than the 0.4 percent median estimate. On the year, GDP was up 1.2 percent, slightly less than the consensus estimate of 1.3 percent. Eurozone second quarter growth was affected by the Greek crisis and the continuing slowdown in China. Both factors hit business confidence and partially offset the positives of a weaker euro, cheaper oil prices and rock-bottom interest rates. Growth stagnated in France and slowed to 0.2 percent in Italy in the second quarter, while advancing slightly to 0.4 percent in Germany. Weaker industrial output in June held back growth in all three countries. Spain was the top-performing big economy in the quarter, advancing by 1.0 percent, while France's flat growth was the weakest performance. In addition to France, Italy and Germany, second quarter growth was also weaker than expected in the Netherlands and in Portugal.

Germany

ZEW's July current conditions gauge was up 1.8 points to 65.7, a three month high. However, expectations dipped a further 4.7 points to 25.0, their lowest mark since November 2014. The buoyancy of the current conditions measure suggests that recent developments in Greece (and China for that matter) have had only a limited impact on analysts' perceptions of where the German economy stands. However, the downgrading of expectations is consistent with recent economic data that have suggested a somewhat disappointing second quarter. Nonetheless, ZEW maintained that the overall economic outlook for the country remains positive.

United Kingdom

Following a revised increase of 200 (down from 7,000) in the claimant count unemployment in June, it declined 4,900 in July. The jobless rate held at a lowly 2.3 percent for a fifth month. The ILO measure showed unemployment up 25,000 over the three months to June. However the LFS jobless rate remained at 5.6 percent. Moreover, in June alone the jobless rate dropped to 5.5 percent from 5.8 percent. The ILO result matched the 5.6 percent jobless rate forecast of Bank of England staff for the three months to June, published in the August Quarterly Inflation report. Total average earnings in the three months to June increased only 2.4 percent, down from an annual 3.2 percent higher last time.

Asia/Pacific

Japan

The decline in producer prices worsened in July and is not helping Bank of Japan's fight against deflation. July producer prices dropped a greater than expected 3.0 percent from a year ago after declining 2.4 percent in June. On the month, the index was 0.2 percent lower for a second month. Excluding the sales tax effect, the PPI was down 2.9 percent after declining 2.4 percent the month before. The decline in part was from the continuing impact of the drop in petroleum & coal product prices which were down 22.8 percent from a year ago after sinking 20.4 percent in June. Iron & steel were also lower by 3.2 percent for a second month. The decline in chemicals and related products accelerated to 7.2 percent from 6.5 percent in June.

June seasonally adjusted machine orders (excluding volatile items) declined for the first time since February. They dropped a larger than anticipated 7.9 percent on the month and were up 14.7 percent on the year. Core orders were up 16.6 percent based on the original series. This was in contrast to expectations for a 17.5 percent increase. Core machine orders are considered a proxy for private capital expenditures. The downward move followed a 0.6 percent gain the month before. The government repeated its assessment that machine orders would advance in the third quarter. Nonmanufacturing orders excluding volatile items were up 5.0 percent while manufacturing orders dropped 14.0 percent. All orders including volatile items dropped 6.2 percent on the month. Manufacturing orders likely softened on continued weaker export demand while the sluggish domestic economy weighed on nonmanufacturers.

China

China's trade figures shocked analysts. July's unadjusted merchandise trade surplus was $43.0 billion, down from $45.7 billion in June. Exports plunged 8.3 percent against expectations of a 3.0 percent drop. Imports sank 8.1 percent against expectations of an 8.0 percent drop. The year to date trade balance was $305.2 billion compared with $212.9 billion in the same period a year ago. For the seven months through July, exports were down 0.8 percent on the year while imports dropped 14.6 percent. On a seasonally adjusted basis, exports slid 3.4 percent on the month after increasing 1.5 percent in June. Imports declined 3.8 percent after jumping 6.9 percent in June. On the year, seasonally adjusted exports dropped 7.9 percent while imports were 8.4 percent lower.

July's consumer price index met expectations and was up 1.6 percent from a year ago. In June, the CPI was up only 1.4 percent. The increase was attributable to food prices which were up 2.7 percent after increasing 1.9 percent in June. The Urban CPI was up 1.7 percent while the rural CPI was 1.5 percent higher. On the month the index added 0.3 percent. For the year to date, the CPI was up only 1.3 percent.

Producer prices continued to languish, dropping 5.4 percent on the year. This was the largest decline since October 2009. The index was 0.7 percent lower on the month. Year to date, the PPI was down 4.7 percent after declining 4.6 percent in the five previous months. Consumer goods prices retreated 0.3 percent while raw materials procurement, fuel and power dropped 6.1 percent. Production materials sank 6.9 percent.

New data show industrial production slowed in July to a pace of 6 percent on the year, its weakest since April and down from 6.8 percent in June (which was its best reading since December). Year to date, output was up 6.3 percent for a second month. Analysts had anticipated a pace of 6.6 percent. Output increased 0.32 percent from June. Motor vehicle output plunged 11.2 percent from a year ago after edging up 0.7 percent in June. Most sub-categories were weaker than in June. Communication edged up to an increase of 9.4 percent from 9.2 percent the month before. Among the industries that were weaker in July were textiles, chemicals, non-metal minerals, ferrous metals, machinery and transport equipment. The figures offer more evidence of a renewed slowdown in China's economy. An earlier reported slowdown in exports was widely cited as a key reason that persuaded the People's Bank of China to change the way it values the renminbi.

Americas

Canada

June manufacturing sales were up a less than expected 1.2 percent for the second consecutive gain and the third increase since January 2015. On the year, sales declined 3.1 percent. Expectations had been for a monthly increase of 2.5 percent. In volume, sales were up 0.5 percent. Sales increased in 18 of 21 industries in June, representing 80 percent of the manufacturing sector. Higher sales of chemical products and motor vehicles led the gains. Lower sales of fabricated metals partly offset the advance. Unfilled orders continued their slide, down 1.8 percent from May. With this most recent decline, unfilled orders have fallen for five consecutive months, a trend that has not occurred since 2009. New orders rose 0.6 percent reflecting widespread increases led by the computer and electronic product industry as well as the chemical product industry. The gains were offset by declines in the aerospace industry.

Bottom line

Investors reacted negatively to China's devaluation of its currency. Emerging markets were hit especially hard. Most equity indexes retreated on the week. Eurozone growth weakened in the second quarter according to flash estimates. In China, data disappointed and was highlighted by the plunge in July exports and imports.

At the end of the upcoming week we will get our first look at provisional manufacturing PMIs for August in China, Japan, the Eurozone, Germany and France as well as the United States. Inflation data for the UK will be closely monitored given that the Bank of England is expected to increase its key interest rate in the first quarter of 2016. The Federal Reserve publishes its minutes from its July meeting. Fed watchers will cull the minutes for any clues regarding when rates will begin to be normalized.

Looking Ahead: August 17 through August 21, 2015

Anne D Picker is the author of International Economic Indicators and Central Banks.