What Currency Traders Should Be Watching Following The China Devaluation

In a new report, Deutsche Bank analyst Alan Ruskin discusses the growing number of ways that the current forex environment resembles that of the late 1990s. Ruskin makes nine observations about the currency world and China’s recent devaluation of the Renminbi (RMB).

1. The move is yet another indicator that pegged currency regimes are vulnerable, which comes during a period in which USD pegs are exposed to a FOMC tightening cycle.
2. The decision demonstrates that carry trades, which are typical of forex peg regimes, produce larger, more volatile “busts” when the peg is eliminated.
3. The presumption that the elimination of a peg will simply lead to a direct movement to equilibrium price is misguided, and Ruskin believes a RMB overshoot is to be expected before equilibrium is eventually reached.
4. Ruskin expects that China will attempt to avoid a “hard-landing” for the RMB by intervening to stabilize the currency at no more than 5 percent devaluation, but he believes that the market will eventually “push hard for a second round of RMB weakness.”
5. There will now be prevalent fears of a domino effect among other pegged Asian currencies.
6. The USD strength rotating from the JPY to the “fragile 5” to the EUR, to commodity currencies and finally to China is not a particularly unusual cycle.
7. While the rotation cycle may seem to be an indication of macro story rotation, Ruskin believes the true driver is policy divergence.
8. Competitive devaluations are also at the core of this rotation cycle as countries attempt to keep up with trading partners.
9. The USD has gained 20 percent on a TWI basis in the past year, more than it has ever gained in the 12 months prior to the first FOMC rate hike of a new tightening cycle. This phenomenon may be because the end of QE was seen by the currency markets as a relative tightening in itself.