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ETF Areas Under Focus on China's Yuan Devaluation

Sanghamitra Saha

China has been in the headlines for the last one-and-a-half years for trade war with the United States. While the world’s second-largest economy has been reeling under pressure for long given the slowdown in the domestic manufacturing sector, credit crunch and about 30-year low economic expansion, increased U.S. tariffs on about $550 billion worth of Chinese goods made the matter worse.

Washington has already imposed tariffs of 25% on $250 billion of Chinese goods so far and Trump announced this month that he will levy 10% tariffs on $300 billion of Chinese goods from Sep 1. Beijing has so far retaliated with tariffs on $110 billion of American goods, including agricultural products.

But as a retaliatory move to the new round of tariffs, China devalued its currency drop to an 11-year low and reportedly stopped purchases of U.S. farm products. On Aug 5, China's central bank set the yuan’s daily reference rate below the politically sensitive level of 7 per dollar for the first time in over a decade. The move triggered a market bloodbath amid fears of a currency war. U.S. stocks witnessed their biggest loss of the year on Aug 5.

Per a multi-asset investment manager, “currency is the most effective lever to offset the impact of tariffs,” as quoted on CNBC. If the yuan drops about 8%, U.S. companies would have to experience only a 2% jump in importing Chinese goods. This is because a lower yuan would reduce the cost of imports to U.S. companies and any add-on tariffs on the price tags would keep the after-duty price almost at a level where it was before the imposition of the duty.

"In the short term, the yuan's strength would be largely determined by the domestic economy. If third-quarter economic growth stabilizes, the yuan could stabilize around 7.2 or 7.3 level," Zhang Yi, chief economist at Zhonghai Shengrong Capital Management in Beijing, told Reuters.

However, such a big move in the Chinese currency market will definitely leave an impact across the globe. Below we highlight a few asset classes and their ETFs, which may be among the biggest movers.

Currency

Needless to say, the move will lead the Chinese currency ETF Dreyfus Chinese Yuan Fund CYB to losses while dollar ETF Invesco DB US Dollar Index Bullish Fund UUP will gain strength. CYB lost 1.9% on Aug 5 (read: Will Dollar ETFs At All Weaken if the Fed Cuts Rates in July?).

Aussie dollar has also suffered following the announcement, putting Australia ETF Invesco CurrencyShares Australian Dollar Trust (FXA) at risk. Per market watchers, the Australian dollar is often regarded as a liquid proxy for the Chinese currency. China is a major trading partner of Australia and thus the currencies of the duo share a high correlation.

Currencies like the Singapore dollar, South Korean won and Taiwan dollar could be stressed as these countries are manufacturing destinations and thus act as competitors to China on the export front. There could be a currency war among these Asian tigers in the near future.

Global Equites

As we already know that the South Korean and Taiwanese economies thrive on exports, these nations could now be losing on currency competitiveness to China. Also, the devaluation makes it less beneficial for Chinese consumers to buy foreign goods, hurting economies that sell goods to the China market.

There are several South Korean companies namely Samsung Electronics, Hyundai Motor, LG Corp. and Daewoo which have big export markets. Taiwan houses one of the largest semiconductor companies in the world – Taiwan Semiconductor. In short, these two countries’ stock markets could be hit by yuan devaluation in a passive way. This put pressure on iShares MSCI South Korea Capped ETF EWY (down 4.3% on Aug 5) and iShares MSCI Taiwan Capped ETF (EWT) (down 3.0% on Aug 5).

Other countries like Indonesia and Malaysia could also lose. Threats lie for “Malaysia in terms of tourism and general trade, and then Indonesia from a competitive standpoint for cheap labor (but also commodities as well).” iShares MSCI Indonesia ETF EIDO lost 5.1%. However, iShares MSCI Malaysia ETF EWM was off about 2% on Aug 5 (read: Country ETFs to Watch as Trade Rout Continues).

Gold

Gold is now caught between higher safe-haven demand and possible lower import demand from China. A stock market rout is great for gold investing as the metal acts as a safe-haven asset. On the other hand, currency devaluation will likely curb the import demand for gold from China (which is key gold consuming nation) as a feebler currency will make imports pricier. SPDR Gold Shares GLD should thus be closely watched (read: Top ETF Stories of July).