It may not seem like it now, but China’s falling yuan (CNHUSD=X) could eventually strengthen U.S. stocks, according to one strategist.
“First, it will hurt all risk assets because of the shock of seeing such a large devaluation to new yuan lows,” said Nick Colas, co-founder of DataTrek Research, in an email to Yahoo Finance.
Like clockwork, when news early Monday broke that China allowed its yuan to weaken past 7 against the dollar - an important psychological level - stocks around the world plummeted.
“The fact that [China has] now stopped defending 7.00 against the dollar suggests that they have all but abandoned hopes for a trade deal with the U.S.,” wrote Julian Evans-Pritchard, senior China economist with Capital Economics in a note to clients. “In a statement likely to anger Trump, the [People’s Bank of China] has explicitly linked today’s devaluation with the renewed tariff threat made by the U.S. last week.”
In a tweet Monday, President Trump called China’s move a “major violation.”
Good for U.S. stocks in two ways
Looking beyond the initial reaction, Colas is eyeing a possible positive chain of events for U.S. stocks.
“It could be good for U.S. stocks in two ways,” Colas said. “First, yields will decline as global investors seek out safe-haven assets like Treasuries. That helps valuations. Second, it accelerates the move out of global equities (especially emerging markets) and into U.S. stocks.”
The 10-year Treasury yield (^TNX) moved lower on news of the yuan devaluation, dropping to 1.782%, marking its lowest level since October 2016.
In terms of areas of the market that may benefit the most, Colas pointed to yield plays.
“The usual yield plays will work first: Utilities, Consumer Staples and Real Estate,” he said. “Probably in that order.”
How the Federal Reserve is watching
The market is now pricing in a 100% chance of a rate cut at the Federal Reserve’s September meeting, according to CME futures data. The probability of a 25bp cut in September stands at 81.2%, while the 50bp cut odds stand at 18.8%. The probability of a 50bp cut in September stood at just 1.5% on Friday.
The market uncertainty and global currency fluctuations from the yuan’s devaluation may prompt a more aggressive response from a Fed that was reluctant to commit to more rate cuts, after last Wednesday’s cut.
“Every time the trade war ratchets up, the Fed is boxed in tighter,” said Danielle DiMartino Booth, CEO of Quill Intelligence and a former Fed advisor. “The hit to confidence will reverberate across the entire economy that was already in a fragile state, hence the outsized moves in stocks and bonds in response to the [yuan] news.”
Federal Reserve Governor Lael Brainard is set to speak at a conference on Monday afternoon. While the remarks are set to cover the payments space, market participants await any possible commentary on the recent trade war and yuan developments.
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Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.
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