Goldman says China yuan move is attempt to get ahead of Fed

[NEW YORK] China's shock devaluation of its currency is designed to cushion it from strengthening along with the dollar after a projected interest-rate increase from the Federal Reserve, according to Goldman Sachs Group Inc.

"This is about Fed liftoff most obviously and further dollar strength," Robin Brooks, chief currency strategist at Goldman Sachs in New York, wrote in a note to clients.

"It certainly makes sense for China's policy makers to buy some flexibility ahead of Fed liftoff, in particular since the fix had become very peg-like in its stability in recent months."

Goldman Sachs projects the dollar strengthening 20 per cent on a trade-weighted basis by the end of 2017.

The yuan sank Wednesday, completing its biggest two-day rout since 1994 - when China ended a dual-currency system - and prompting the People's Bank of China to intervene. The central bank sparked the declines a day earlier when it cut its daily reference rate by 1.9 per cent.

China has stepped up efforts to boost traditional drivers of growth as new ones fail to offset slowing investment and trade. Developing markets are feeling the strain as domestic expansion slows, while the US nears its first interest-rate increase in almost a decade.

Until Tuesday, China had kept the yuan little changed against the dollar, effectively pushing it higher against other emerging-market currencies and hurting its exporters. A Bloomberg gauge of the dollar against 10 major trading partners has climbed 6.5 per cent this year, as futures traders raised the odds of a September rate increase to as high as 54 per cent last week.

"The market pressures have been for a weaker yuan, and in order to maintain the stability of the currency, the PBOC has basically been having to sell US dollars," said Ray Attrill, global co-head of currency strategy at National Australia Bank Ltd. in Sydney.

"Maybe this is the PBOC stopping the defense of a stable yuan ahead of what the Fed may or may not do as early as next month." While the change is reminiscent of Swiss abandonment of the franc's ceiling versus the euro in January, which anticipated quantitative easing from the European Central Bank, China isn't looking to push the currency significantly weaker, according to Brooks at Goldman Sachs.

"Our bias is that the move overnight was more about buying flexibility as opposed to the beginning of a large devaluation trend," Mr Brooks wrote.

BLOOMBERG