QuickQ

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This section provides quick commentaries to market questions that may arise on any given day. They provide minimal context as a working knowledge with the general market environment and its issues is assumed. The style is more colloquial than in other writings. For more detailed analyses, please refer to the main blog entries.

Why does China’s 3% mini-deval matter so much?

1. Unusual scale: The 1.9% adjustment of the USDCNY reference on August 11 was large by Chinese standards. The only time, the PBoC made such a large policy-induced move was when it de-pegged from the USD in 1995 (which was in the opposite direction).
2. Policy conflict: It was important to bring exchange rate-and monetary policy in line. The PBoC was tightening liquidity to support an exchange rate under depreciating pressure and easing rates and RRR to ease monetary policy and support growth.
3. Market role: Most importantly, the PBoC announced that it would change the calculation method for the reference rate. It will no longer average quotes/estimates from dealers on the morning of the trading day, but instead use the previous day’ closing price. This gives a greater role to market forces in determining the exchange rate (especially if  accompanied by a widening of the fluctuation band later on) and makes the PBoC’s policy tilt apparent in the deviation between closing and opening price.

Why is a mere 25bps hike by the Fed so important?

1. Partly, it has to do with levels: if the Fed Funds rate were currently at 3% or 4%, a 25bps hike would figure much less prominently in the market’s attention. From the current top of the Federal Funds target range, a 25bps raise represents a 100% increase.
2. Partly, it has to do with timing: this will be the first rate hike since mid-2006. What is more, fears that the Fed may fall “behind the curve” in fighting inflation and may have to raise rates aggressively (as in 2004) still preoccupy some market observers.
3. And finally, the timing of the first rate move will provide an indication as to how the Fed positions itself in the debate about “secular stagnation” and whether it believes the long term equilibrium interest rate has fallen (which in turn will give an idea about the future path of rates).

Why is EURUSD so strong amidst all this market dislocation?