BOSTON (Reuters) - Looking at Wall Street’s initial surge on Monday, you could easily conclude China’s lifting of the peg that had kept its currency in lockstep with the dollar for the past two years was an unmitigated boon for corporate America.
If you did, you would be overlooking some important risks, analysts and investors warned.
Beijing’s move to allow the yuan to rise against the dollar is good news for miners and other companies that supply the commodities and equipment that the world’s third largest-economy needs to fuel its growth, by making U.S.-made equipment comparatively cheaper in China and making Chinese-made goods more expensive in the United States.
Shares of many U.S. companies that sell to China rose sharply in early trade on Monday, but the market slid later as hopes that the country’s newfound dedication to yuan flexibility turned to doubts about the speed and magnitude of Beijing’s intentions.
Companies ranging from heavy equipment maker Caterpillar Inc to fast-food operator Yum Brands Inc to furniture retailer Ethan Allen Interiors Inc said the move, which allowed the currency to rise to a five-year peak, would likely be a positive for their business.
But there are also risks. Among them, an economic slowdown in Europe that could weaken the yuan against the dollar, reversing an upward trend that has held since 2005 when Chinese authorities first lifted a long-standing dollar peg. Europe currently absorbs about 20 percent of China’s exports.
Beyond that, China’s policy of managing its currency’s exchange rate with the dollar — which U.S. economists and politicians say has overvalued the yuan by as much as 40 percent — has required Beijing to buy large amounts of U.S. debt, thus increasing the supply of yuan on international markets while decreasing the supply of U.S. assets.
Given the United States’ tendency toward deficit spending, which was exacerbated by last year’s $787 billion stimulus package and the bailout of the U.S. financial sector, that could force U.S. interest rates higher and risk derailing the nascent economic recovery.
In addition to looking to smooth over one of the thornier aspects of U.S.-China trade relations ahead of this week’s G-20 meeting, Beijing may have shifted its stance on exchange in reaction to the falling euro, which earlier this month hit a four-year low versus the dollar, though it has since rebounded modestly.
“The reason the Chinese have become more cautious about their currency is because of what’s happened in the euro zone. As the dollar has risen against the euro, that means that China’s currency has risen against the euro,” said Ira Kalish, director of global economics at Deloitte Research.
That has made Chinese exports more expensive in Europe. Coming at a time when Europe’s economy is slowing, that is bad news for Chinese manufacturers, who ship about 20 percent of their exports to Europe.
If weakening European demand hurts Chinese exports, the yuan could fall versus the dollar, rather than rise, suggested Peter Sorrentino, senior vice president and portfolio manager at Huntington Asset Advisors in Cincinnati.
“It could go in the other direction, that’s my fear, especially if we see the austerity measures in Europe continuing to drive those economies down,” Sorrentino said.
Allowing the yuan to decline in value would also mean Chinese authorities have less need to buy U.S. debt, Sorrentino pointed out.
“They’re already easing away, gradually, from a heavy reliance on rolling into U.S. paper,” Sorrentino said. “We could easily see interest rates in the U.S. coming up.”
Still, anything that increases the ability of Chinese businesses and consumers to buy U.S. made products represents a boon to U.S. businesses, executives said.
“China now has more purchasing power, their consumers have more purchasing power, so it cheapens their imports at the expense of their exports,” said David Weaver, president of U.S. money manager Adams Express Co, of Baltimore, Maryland, which holds shares of companies including General Electric Co, and United Technologies Corp.
The move could boost sales for companies including Emerson Electric Co, United Tech and Caterpillar, Weaver said.
“For manufacturers that are competing against Chinese companies, it gives them a little bit of an advantage,” Weaver said.
Others noted a stronger yuan would boost companies ranging from miners including BHP Billiton plc, to companies that supply them, like Caterpillar and rivals Bucyrus International Inc and Joy Global Inc.
But many multinationals manufacture at least some of the heavy equipment they sell to China in that country, which would temper any currency benefit.
A spokeswoman for GE, which takes such an approach, said the largest U.S. conglomerate, did not expect any material impact from the change.
Yum Brands Inc, which owns the KFC and Pizza Hut fast-food chains and generates more than one-third of its profits from its 3,500 locations in China, regards the move as good news, spokesman Jonathan Blum said.
“China represents our No. 1 growth opportunity and we expect this to be a very positive development over the long-term,” Blum said.
A stronger yuan would also make the low-cost consumer goods that many U.S. retailers buy from China more expensive, though Deloitte’s Kalish said some could offset that effect by moving production away from China’s coastal cities, where wages are rising, to poorer inland areas.
U.S. furniture retailer Ethan Allen Interiors Inc believes the change could have a “neutral to positive” effect on its performance, Chief Executive Farooq Kathwari said at the Reuters Global Retail Summit in New York.
That Beijing made this move at all suggests it has confidence in its economic growth, analysts said.
“I don’t think they would have made the move unless they thought the economy was in a pretty good position to handle it,” said Jeff Windau, industrial analyst at Edward Jones in St. Louis. “People are reading that as a sign that the Chinese economy is a little bit more stable, has a little bit more solid base than some people expected.”
Reporting by Scott Malone, additional reporting by Lisa Baertlein in Los Angeles, editing by Leslie Gevirtz