Will China Weaken the Yuan to Boost Its Market?

By Sam Mattera
Benzinga Guest Writer

In the second half of 2010, David Tepper achieved a level of notoriety after he had made the correct call on equities for the second half of that year and the beginning of 2011.

Tepper suggested investors get bullish. He made this recommendation on a simple assumption: either the economy improves, in which case equities should rally, or the economy does not improve, in which case the Federal Reserve boosts the market with additional easing measures.

Following Tepper's call, in November, the Fed unleashed the second round of quantitative easing. QE2 elevated markets higher, as equities traded up for most of the first half of 2011.

Now, are investors seeing much the same situation in China?

On Tuesday, Chinese GDP beat estimates, coming in at 8.9%. This was widely hailed by market pundits as being an ideal reading—slower, so as not to push inflation, yet not so low as to an indicate a “hard landing.”

The Shanghai Composite rallied strongly in the wake of the report, gaining over 4% on the session. The index had been badly beaten down in recent months, as investors may have become concerned with China's future growth prospects.

Tuesday's Shanghai rally may have been in reaction to investors anticipating a far lower number. 8.9%, while great for a developed nation, is comparatively poor for China.

The rally may have been motivated more so by easing expectations. With growth slowing, Chinese officials may have no choice but to engage in large-scale easing.

China's leadership is set to change this year, and the People's Bank of China has already signaled their willingness to ease, as they have recently cut reserve requirements.

That additional yuan circulating in the economy could mean higher asset prices and a better market in China. It may also mean China's aggressive expansion continues, which could support commodity prices and related economies like Australia and South Korea.

Yet, are investors set to be disappointed? With Chinese GDP reporting lower, the Asian could economy have more downside from here, even if Chinese officials ramp-up easing policies.

In terms of the USD/CNY, the currency pair could show strength. The pair rallied slightly on Tuesday—yet, as the PBoC directly pegs the value of the yuan, the currency's movement is limited.

One way for the PBoC to ease would be to change its peg. Although some have predicted that the PBoC would increase the peg—making the yuan stronger to fight inflation—it may be more likely that the PBoC will weaken the yuan by lowering the peg. That would be bearish for the value of the yuan relative to the dollar.

At any rate, China continues to be a major player in the global economy. US equity markets traded higher on Tuesday, perhaps due to the rally seen on the other side of the globe.