China's move to adjust the mechanism for determining the USDCNY fixing sent shockwaves through EM rates and FX markets. The large movements in EM FX markets have fuelled speculation of weaker growth outcomes in China, a renewed currency war via competitive devaluations and another factor restraining inflation globally. The biggest effect thus far has been in rates and FX in manufacturing economies in Asia. The Figure shows the change in the level of the overnight rate being priced in 1y and FX versus the USD since the CNY fixings started moving. Outside of CEE, rate expectations have moderated for the most part and currencies have sold off.

The sensitivity of EM currencies in general to gyrations in the CNY has increased over recent months and if China stands by its word that the market will have a greater influence on CNY movements, this sensitivity is expected to continue to increase, argues Barclays. That said, the PBoC's comments in a press conference on 13 August1, along with FX intervention and administrative measures to slow the CNY's decline, suggest that the PBoC does not intend to devalue the CNY sharply and implies heavy FX market intervention in the coming days to smooth the currency move. USDCNY is likely to continue to head higher, however, and FX volatility to remain elevated, with larger expected changes in China's FX reserves in the coming weeks, adds Barclays.