August 11, 2015 / 12:30 AM / in 2 years

Yuan cut clobbers markets, rekindles fear of forex war

A bank clerk counts U.S. dollar banknotes on bundles of 100 Chinese yuan banknotes at a branch of a bank in Huaibei, Anhui province April 26, 2012.Stringer

SAN FRANCISCO (Reuters) - China's 2 percent devaluation of the yuan hit global equities and U.S. oil prices on Tuesday with investors fearing a new currency war as well as declining Chinese economic momentum.

Wall Street ended lower as investors contemplated the implications of a move designed to support China's slowing economy and exports. The MSCI All World Index .MIWD00000PUS of global shares fell 1 percent.

"What is good for growth in China is unfortunately bad for everybody else," said Bill McQuaker, co-head of the multi-asset team at Henderson Global Investors.

The Dow Jones industrial average .DJI fell 1.21 percent to finish at 17,402.84 and the S&P 500 .SPX moved 0.96 percent lower to 2,084.07. The Nasdaq Composite .IXIC dropped 1.27 percent to 5,036.79.

Oil prices declined as dollar-priced commodities became more expensive, weighing on demand. U.S. crude CLc1 lost more than 4 percent to $43.08 a barrel, its lowest settlement since March 2009.

"It's time to sell any and all rallies," said Tariq Zahir, managing member at Tyche Capital Advisors in Laurel Hollow in New York, who believes oil prices are heading lower.

Companies that sell to China were hit hard, with heavy equipment maker Caterpillar (CAT.N) losing 2.65 percent. Natural resource company Freeport-McMoRan (FCX.N) dropped 12.27 percent.

The pan-European FTSEurofirst 300 index .FTEU3 lost 1.68 percent, led lower by car makers and luxury goods companies, whose products are now more expensive for Chinese consumers.

Against the trend, Greek shares .ATG gained 2.14 percent after Athens secured a third bailout deal with creditors.

On Chinese stock markets, airlines and importers fell, though exporters rose. The CSI300 index .CSI300 of the largest listed companies in Shanghai and Shenzhen lost 0.4 percent and the Shanghai Composite .SSEC closed flat.

BIGGEST FALL IN YUAN SINCE 1994

China's move, which the central bank described as a "one-off depreciation" based on a new way of managing the exchange rate that better reflected market forces, triggered the yuan's biggest fall since 1994, pushing it to its weakest against the U.S. dollar CNY=CFXS in almost three years.

In a potentially worrisome sign, China's offshore yuan CNH=, a more liquid instrument traded out of Hong Kong, fell 2.9 percent, exceeding the fall in the onshore yuan. It suggests more possible losses for the onshore currency, as the Hong Kong-traded yuan tends to act as a precursor to the onshore.

Emerging market currencies, which have already fallen sharply in the past year as the U.S. dollar has strengthened, slumped again.

The Malaysian ringgit MYR= and the Indonesian rupiah IDR= hit lows not seen since the Asian financial crisis 17 years ago while the U.S. dollar gained 2.2 percent against Brazil's real BRL=, putting it in range of levels not seen since 2003.

The euro hit its highest against the dollar in a week and a half, at $1.10890, before paring gains.

The weakness in stocks boosted top-rated bonds. German 10-year yields DE10YT=TWEB fell 5 basis points to 0.64 percent and U.S. equivalents US10YT=RR dropped 11 basis points to 2.1248 percent.

CURRENCY WARS?

Washington has for years pressed Beijing to liberalize its control of the yuan to allow it to strengthen given China's high rate of economic growth and massive exports.

But Chinese growth is now slowing and the new exchange rate mechanism gives markets greater ability to push the yuan lower, just as the United States prepares to raise interest rates, a step that may add further to U.S. dollar strength.

Investors are now wondering whether China's devaluation will keep the Federal Reserve from raising U.S. rates in September as many anticipate.

"People seem to be trading this as a reason for Fed delay," said Michael Wallace, global market strategist at Action Economics in San Francisco. "This puts the Fed tightening horizon back on the table in terms of discussion."

The big question now for emerging markets, where economic growth has slowed and capital flight has increased, is whether their officials respond to China's move in kind.

"The key will be the response of other central banks ... There should be further pressure on the currencies of China's trade partners," said Nick Lawson, managing director at Deutsche Bank in London.

Additional reporting by Noel Randewich in San Francisco and Jemima Kelly, Marius Zaharia, Sudip Kar-Gupta and Clara Denina in London; Editing by Meredith Mazzilli and James Dalgleish

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