Will China’s Troubles Continue to Haunt the Forex Market?

It wasn’t too long ago when China’s stock market nightmare wreaked havoc on forex risk appetite, as investors braced themselves for a potential global economic meltdown in mid-2015. Fast forward six months later, Chinese equity troubles came back with a vengeance as soon as the new year kicked off, hinting that the worst ain’t over yet.

How bad is it?

China stocks forexBarely a few weeks into the year, the Shanghai Composite Index is already down by 11.7% and counting. This sent a wave of panic across markets all over the world, causing global equity indices to chalk up back-to-back losses reminiscent of the market turmoil back in 2008, according to George Soros.

The S&P 500 and Dow 30 indices were off to their worst start in a year in almost a century while the London FTSE has lost roughly
£30 billion in the first four days of this week. The carnage carried on to commodity markets, with crude oil dipping to 11-year lows on concerns of a massive downturn in demand from the world’s second-largest energy consumer.

What started all this?

It’s difficult to pinpoint which catalyst is to blame for the latest rout in China, as the country’s fundamentals have been weakening for quite some time. Perhaps what pulled the rug from under the stock market’s feet was the downbeat Caixin manufacturing PMI, which reflected a deeper industry contraction in contrast to the government’s relatively upbeat data released much earlier.

Another likely reason for this week’s bloodbath was the looming expiration of the short-selling ban on securities, although Chinese officials soon decided to extend this lockup by three more months to prevent sharper equity price declines. When it became clear that this decision wasn’t enough to keep shares afloat, authorities halted trading merely 29 minutes after markets opened on Thursday as a “circuit breaker” before all hell broke loose.

Did that work?

Not really. In fact, the Chinese government’s desperate efforts appear to be stirring up more nervousness in the financial markets, as it becomes apparent that even the top officials are unable to do anything to stop the bleeding.

According to economic gurus, this is the start of a much-needed correction in the Chinese market, as the previous stock rallies haven’t really been supported by strong fundamentals but rather government intervention or pure speculation. “The bottom line is the market is not supported by fundamentals,” said Andy Xie, an independent economist based in Shanghai. “People in the know want to get out.”

What could this mean for forex trends?

If the forex price action of the Aussie and the Kiwi last year is any indication, it’s that these commodity currencies could experience the biggest drag from a continued slowdown in China. After all, Australia and New Zealand export a bulk of their raw material commodity products to China and risk aversion usually takes a huge toll on higher-yielding currencies. Talk about a double-whammy!

Although the U.S. dollar tends to benefit from risk-off flows, it looks like its safe-haven appeal is being diminished since the U.S. stock market hasn’t been immune from China’s hiccups. Some say that the euro might actually be able to take advantage of all this, with moolah expected to flow away from China and back to Europe. For now, it looks like the Japanese yen is also able to stay afloat as Asian investors look for lower-yielding holdings.