Fed Hike in Doubt After Yuan Devaluation

The move by the People’s Bank of China overnight to change the way it calculates the daily midpoint against the dollar, devaluing the Yuan by 2% in the process, could have a significant impact on whether the Federal Reserve decides to hike interest rates this year.

The PBOC’s decision was intended to make the midpoint more market orientated which in actual fact could be argued to be a move away from intervention, contrary to what has been suggested as it takes into consideration market forces. In reality, given the timing after another batch of woeful export numbers over the weekend, there does seem to be an element of knee-jerk reaction about it in a bid to make Chinese exporters more competitive.

The question now is whether other central banks will follow suit and devalue their own currencies in some way in an attempt to ring-fence their own export markets, something that could further harm US companies. They are already facing a battle to compete as a result of the strong dollar, which was likely to be further hampered by a rate hike from the Fed when it raised rates.

The deflationary impact that such moves could have on the U.S. is likely to up the pressure on Fed policy makers intent on raising rates sooner rather than later. The country is already experiencing low levels of inflation as a result of the strong dollar and tumbling commodity prices. A rate hike this year already appeared to be on a knife edge, this could be enough to tip it over into next. That may now depend on the actions of other central banks.

Greece appears on the verge of securing the bailout funds agreed in principal last month following some of the smoothest negotiations seen throughout the crisis. A Greek official has claimed that, as planned, Greece has come to an agreement with its creditors barring a few minor details which should then be put in front of parliament on Thursday and hopefully backed by finance ministers on Friday. The deal will enable Greece to make a €3.2 billion payment to the European Central Bank on 20 August and recapitalize the banks that were depleted due to the uncertainty over whether Greece would leave the eurozone. An announcement is expected regarding the deal during the European Commission’s midday briefing.

On the data side,. Preliminary unit labour costs and non-farm productivity figures will be released ahead of the open today. Figures over the last couple of quarters regarding labour costs have been very high and suggested that inflationary pressures are returning. No change is expected in labour costs in the second quarter which would comply with other data already seen, which further suggests that employers are looking to suppress wages in an attempt to keep prices competitive and offset the competitive disadvantage of the strong dollar. Productivity is also expected to remain fairly weak by historic standards, although a small bounce back from two negative quarters is expected.

The S&P is expected to open 14 points lower, the Dow 142 points lower and the Nasdaq 18 points lower.

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Craig Erlam
Based in London, England, Craig Erlam joined OANDA in 2015 as a Market Analyst. With more than five years' experience as a financial market analyst and trader, he focuses on both fundamental and technical analysis while conducting macroeconomic commentary. He has been published by The Financial Times, Reuters, the BBC and The Telegraph, and he also appears regularly as a guest commentator on Bloomberg TV, CNBC, FOX Business and BNN. Craig holds a full membership to the Society of Technical Analysts and he is recognized as a Certified Financial Technician by the International Federation of Technical Analysts.