Market Sentiment Deteriorates Following China’s Currency Devaluation

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Risk aversion intensified in August following China’s surprise renminbi devaluation and its shift toward a more market-oriented currency regime. The currency moves magnified market concerns about slowing global growth and inflation, causing pronounced sell-offs in markets for commodities, emerging market currencies, and global equities.

Recent developments:

• China devalued its currency and announced plans to establish a more market-based currency regime.
• Commodity prices, global equities, and emerging market currencies came under significant pressure on concerns that a weakening Chinese economy could diminish global growth.
• The growth concerns and market turbulence have reduced expectations for the Federal Reserve to begin raising interest rates in coming months. The market-implied probability of a rate hike in 2015 is now about 50 percent.
• Puerto Rico’s Public Finance Corporation defaulted on an August debt payment, but with little spillover to broader municipal debt markets.
• Market concerns about Greece receded as its government reached an agreement with other euro area governments for a new financial support program.