Traders were quick to bid up equities and commodities and sell Treasuries after China pledged to once again unshackle the renminbi’s exchange rate. The one clear positive of the move is that China’s leaders have defused protectionist pressure in the US Congress and allowed the leaders at the G20 summit to focus on other pressing matters, but markets seem to have overreacted for now.
The non-deliverable forward market is suggesting renminbi appreciation of just 3 per cent over a year. This is even less significant than it seems since it was already pricing in a move of nearly 2 per cent before China’s announcement. History, too, suggests a modest initial move. The first year of the 2005-2008 crawling peg saw the renminbi appreciate only 1 per cent against the US dollar.
But what seems an outsize reaction to China’s announcement should not distract investors from the profound implications of a potential larger revaluation. Analysts at Credit Suisse reckon the renminbi is 50 per cent undervalued while Chinese inflation recently hit a 19 month high. So, even if external pressure wanes as a result of its latest baby steps, the rationale for a bigger move is building.