China’s devaluation of its currency last month was viewed by some as the most significant sign yet of a slowdown in the country’s economy. While falls in the Shanghai stockmarket and the value of commodities were already underway, the devaluation made other areas of the global market take notice – culminating in the sharp drops seen on August 24.
The renminbi fell by 1.9 per cent on August 11 and by a further 1 per cent the next day, but has since been relatively stable.
China’s decision to allow market forces to play a greater role in setting the value of its currency was judged to be in part a reaction to capital outflows in the country: Chinese FX reserves have dropped from $4trn to near $3.5trn between the start of 2014 and this August, putting pressure on its currency.
But Stanhope Capital CIO Jonathan Bell, writing last month, added China’s decision was largely a result of “the authorities’ hope that a devaluation will provide a boost to exports and the economy”. He added: “Given [this], the fall in the currency to date is probably only part of the eventual move.”
The renminbi has not exhibited any further signs of weakness since the drops of August 11-12. Managers acknowledge the wider social and political forces that drive Chinese policymakers are as important as fundamentals, but suggest the currency may yet fall further.
Michael Mabbutt, manager of the Liontrust Global Strategic Bond fund, is short the renminbi to the extent of about 10 per cent of his portfolio, a position he held prior to the initial devaluation.
“China has opened a Pandora’s box by allowing the currency to depreciate modestly. This, combined with the social impact [of a slowing economy], leads us to believe it will go much further,” he said.
“Typically you need a drop of between 15 per cent and 20 per cent for it to have an effect. That would take us to about 8 as an exchange rate [against the dollar]. I suspect we’ll have a few more devaluations.”
Mr Mabbutt noted this drop would take the renminbi close to the level at which it was pinned to the US dollar between 1997 and 2005.
Another manager who has bet against the currency in recent months is James Clunie, manager of the Jupiter Absolute Return fund. His position, however, acts as a hedge against some of his other investments rather than an outright view on the exchange rate.
“It is meant to be an imperfect hedge for my long positions in deep value equities, things like Ladbrokes and Statoil,” he said. “Given the renminbi had experienced real exchange rate appreciation and there are large capital outflows in China, [the currency] seems overpriced with a negative catalyst. But we are aware these are decisions with other factors involved.”
Mr Clunie acknowledged that the sharp drop in the currency’s value in mid-August had made him wary of maintaining the position, but he said he was doing so nonetheless.
“Although my instinct when you make money quickly by buying something that’s underpriced and revalued quickly [is to trim the position], I am left thinking I need this hedge. If there is [another] devaluation or global deflationary shock, underpriced value stocks will keep falling. So long as I hold those, I need to keep this hedge.”
Acknowledging the wider repercussions of a further fall, as demonstrated by August’s ripple effect, was also on Mr Mabbutt’s mind: “You can look elsewhere. Very broadly speaking, it would have a deflationary impact, which is to say maybe G10 government bonds would do well were that to happen.”
The manager added a more competitive Chinese currency would lead to more trouble for other Asian currencies. As a result, he is short the Taiwanese dollar and recently began shorting the Philippine peso.
The investors agree the risk has become more widely acknowledged but are split on the cost of specifically betting against the currency. Mr Mabbutt said he may increase his short position further, saying it is “not hugely burdensome” to short the renminbi. Mr Clunie, however, said his put option has risen from 0.25 per cent of his portfolio to 1.25 per cent since the devaluation.
“I think it is now fairly priced. I am not sure I would buy it anew, but I am [maintaining it] given I need a hedge against this scenario.”
