As per our observation, the US would have the adverse hit with a blatant financial jolt to derail the economic cycle impulsively. The significant impending cause has already come from PBoC, that a currency regime shifts hampering in many ways.

The CNY would keep depreciating in a baffling patterns to ultimately conclude the year at 6.80. The possibility and insinuations of a more abrupt adjustment to 7.50 triggered by continued capital outflows and depletion of China's liquid FX reserves.

To summarize we would expect the trade-weighted dollar index to appreciate by a further 10% under this scenario, putting cumulative appreciation since the summer of 2014 at 33%. Commodity prices would fall further, with oil down an estimated 10%. This would exacerbate the stress in US high-yield credit, potentially causing a third of the energy sector to default on its debt. US equities would fare better than other regions, but global equities would fall by about 10-15%.

All these factors would constitute a severe financial shock that could in turn cause an adverse hit on the US growth outlook. A 10%-dollar appreciation alone would shave about 0.4% off of growth in the first year, and the equity correction would take off another 0.3%.

The effects of lower oil prices are more difficult to quantify, but given the recent preference to save a significant portion of the energy dividend, the negative impact of defaults would probably overwhelm the positive consumptions effects, at least in the early stages.

In response, the Fed would probably reduce its projected fed funds path by about 100 basis points over the forecast horizon, essentially eliminating the four hikes projected by the dots for 2016.

Would the shock be enough to push the US economy into a recession? Probably not. A more likely outcome is a severe mid-cycle slowdown which pushes GDP growth toward 1%. Labor market progress would stall in this scenario, with the unemployment rate levelling out or possibly drifting slightly higher.

This would defer the normal build-up of late cycle forces (interest rate hikes, wage pressures, etc). So, supposedly in the base case scenario, the next cyclical downturn in 2018/19. Rather than bringing the date forward, further shockwaves related to China's structural adjustments could well delay the next downturn, making this the longest cycle in post-war history. 

Baseline risk scenario of USD/CNY 7.50 not enough to materially slow world GDP, the PBoC must tighten capital controls to slow down the depletion rate of FX reserves.

On hedging perspectives, we recommend, buying USD/CNH call spreads preferred to vanilla calls or long USD/CNH, longs in CNY NDF against TWD or KRW on attractive carry.