Have equity investors around the world finally realized that China’s devaluation of the yuan is good for stocks?

On Thursday, just two days after the Chinese government allowed its currency to float, world stock markets are up. After having a chance to sleep on it, investors appear to realize that removing the yuan from its peg to the US dollar is a good thing for stocks because it eases global deflationary pressures.

Asia Unhedged has been calling for monetary easing in China because we consider the policy of the US Federal Reserve Bank to be wrong-headed.

The big issue has been the inflation component of US Treasury bond yields — the difference between ordinary Treasurys and TIPS (Treasury Inflation Protected Securities). The Treasury inflation component has been rising in anticipation of the Fed’s interest rate hike, while the inflation component in the real world was plunging on global deflationary forces such as falling commodity prices.

By remaining pegged to the dollar, China was importing deflation from the US and suppressing its own exports. The People’s Bank of China did what any competent central bank does when exports fall, it devalued its currency.

But removing the peg did more than just help Chinese exporters; it sent an important message to the rest of the world.

“This was a message to the Federal Reserve that its monetary policy was harmful. (After the devaluation) The fed funds futures market priced down the probability of a future Fed hike,” wrote David Goldman, a managing director of Reorient Financial Markets. “This is positive, not negative, for equities. The consensus view on Monday held that yuan devaluation was a sign of slowing Chinese economic growth. That’s exactly backwards: the slowing economic growth already was in evidence, most prominently in the export sector.”

Goldman writes that the six best performing sectors in the S&P 500 are dominated by energy, “hardly a harbinger of collapsing world demand in the wake of a Chinese devaluation.”

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