•More of the same: China lower, commodities lower, Fed funds lower, dollar lower It was more or less the same pattern Monday as on Friday. With Chinese stocks collapsing and commodities continuing to fall, Fed funds rate expectations continued to retreat and the dollar lost ground against most of its G10 counterparts. The move was aided by a stronger-than-expected Ifo survey. EM currencies meanwhile generally fell against the dollar, with TRY once again leading the way on geopolitical concerns, followed by the currencies of the commodity countries, particularly the oil producers as oil prices lurched lower.
•Some of the eastern European currencies did rather well, however, such as PLN, HUF and CZK. These countries are likely to benefit from stronger European growth, as indicated by yesterday’s Ifo survey, and as oil importers they will also benefit from lower oil prices. It depends on how the fall in commodities is viewed. So far, it’s being viewed as the equivalent of a tax cut – something that leaves more money in the hands of consumers. The question is whether if commodity prices continue to fall, will the decline be seen as an indication of weak demand? That may be the implication from the rally in US bonds. Note that European bonds did not gain yesterday, which is intriguing considering that European stocks were down sharply.
•In any case, the dollar’s rate advantage narrowed slightly and the currency weakened as a result. Whether this trend continues depends a lot on what the FOMC says tomorrow. I expect that the turmoil in Chinese stocks will not derail that Committee and that the statement will echo Fed Chair Yellen’s recent comments about being on track to tighten later this year. That should support the dollar.
•Chinese stock rout could set off another round of currency wars As Chinese stocks collapse, the Chinese government has been taking various measures to shore up the market. Some of them involve direct involvement with the market itself, while others try to improve the macroeconomic background for stocks, e.g. cutting the required reserve ratio for banks. On Friday, the State Council published a set of policy initiatives to promote trade. Exports have been falling on a yoy basis recently, a relatively unusual event for China over the last two decades. The Council probably hopes to boost exports and aid manufacturing, which has been contracting recently, according to the latest PMI report.