Chinese stocks opened lower, extending yesterday's losses, after The PBOC weakened its Yuan FIX dramatically for the 2nd consecutive day (from 6.1162 Monday to 6.2298 last night to 6.3306). Offshore Yuan fell another 9 handles against the USD after China closed but was hovering at 6.40 as the market opens (now at 11 hnadles weaker at 6.51). Bear in mind the utter devastation in Chinese credit markets that data showed occurred in July, it remains ironic that for the 3rd days in a row, Chinese margin debt balances grew. Before the real fun and games started, Chinese officials once again exclaimed that their data is real (denying any mismatches between GDP Deflator and CPI) as China CDS spiked to 2 year highs. US equity futures are tumbling, bonds bid, and gold bouncing off the initial jerk lower.

PBOC makes some comments (like last night's)...

• *PBOC SAYS NO ECONOMIC BASIS FOR YUAN'S CONSTANT DEVALUATION
• *PBOC SAYS YUAN WON'T CONTINUOUSLY DEVALUE
• *PBOC SAYS MOVE OF YUAN REFERENCE PRICE IS NORMAL
• *CHINA YUAN MECHANISM CHANGE MAKES FIXING RATES MORE REASONABLE

And then there is this (from Xinhua):

China's state-owned news 4-year lowsagency Xinhua said: "China is not waging a currency war; merely fixing a discrepancy."

"The central parity rate revision was designed to make the yuan more market-driven and in line with market expectations," it said in a comment piece published on its web site.

"The lower exchange rate was just a byproduct, not the goal."

The "one-off" adjustment has now become two... some context for the size of this move...

• *MNI: CHINA PBOC WED YUAN FIXING LOWEST SINCE OCT 11, 2012

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Onshore Yuan breaks above 6.41 - trades to 4 years lows against the USD...

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US markets are reacting dramatically...

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US Treasury yields are collapsing...

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Offshore Yuan is collapsing...

• *CHINA SETS YUAN REFERENCE RATE AT 6.3306 AGAINST U.S. DOLLAR
• *OFFSHORE YUAN TUMBLES 1.6% AFTER PBOC SETS FIXING LOWER

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War is begun... (via Ransquawk)

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Offshore Yuan has been leaking lower since China closed...

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Yesterday was mixed with the broadest indices all ending in the red...

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• *CHINA'S CSI 300 STOCK-INDEX FUTURES FALL 0.8% TO 3,982.8
• *CHINA FTSE A50 STOCK-INDEX FUTURES EXTEND LOSSES TO 2.6%

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But...

• *SHANGHAI EXCHANGE MARGIN DEBT RISES FOR THIRD DAY (will they never learn?)
• *CHINA STATS OFFICIAL DENIES MISMATCH OF GDP DEFLATOR AND CPI (if you just keep saying evcentually everyone will believe)

GDP deflator index reflects prices of all final goods and services produced in China, much broader than that of CPI which only reflects consumer prices, Xu Xianchun, a deputy head at National Bureau of Statistics, writes in an article in People’s Daily.

We think they do protest too much.

China Credit Risk surged to 2 year highs...

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There’s been plenty of talk about what China’s "unexpected" (to everyone but us, apparently) move to devalue the yuan will mean for the country’s flagging economy and for Beijing’s efforts to promote the internationalization of the renminbi via a bid for SDR inclusion, but as Chinese stocks open for trading on the "day after" (so to speak) we thought it worth previewing what the move might mean for Chinese equities.

We present the following breakdown from Goldman with the obvious caveat that, as Tuesday’s farcical data from the PBoC on loan growth in July made abundantly clear, when it comes to China’s equity markets, one must always factor in the plunge protection "national team." 

From Goldman

Our framework to think about FX depreciation on equities - Three main transmission mechanisms

We try to assess the potential impact of RMB depreciation on the equity markets through various micro and macro channels. In general, we think the macro-to-market transmission mechanisms (especially an unexpected one as in this case) could be summarized as follows:

Translation exposure—Universally, offshore-listed Chinese companies’ book values and earnings (if CNY-denominated) will be deflated when they are being converted into HKD or USD for financial reporting purposes. Lower book values and earnings would increase the P/B and P/E ratios, effectively making Chinese companies less attractively valued to USD-based investors.

Transaction and economic exposure— Assuming other non-USD currencies did not move along with the CNY, export-oriented companies would likely benefit due to a more competitive exchange rate and a mostly RMB cost base.

Impact on equity risk premium (ERP)—Using the exchange rate as a policy tool to manage the cycle should render a higher level of domestic monetary policy independence for policymakers and should partly ease investor concern about further domestic imbalances (e.g. over-investment, overcapacity, debt buildup, etc). Barring an abrupt depreciation case, the higher FX flexibility may shore up investor confidence on China's short-term growth outlook, thereby helping to suppress the currently-high equity risk premium, which seems to have priced in significant macro and micro growth risks, in our view.

That said, the consequential uncertainty regarding capital outflows could offset some of the positives. 

Impact on equities: Not all depreciations are created equal

The abovementioned transmission mechanisms do not take into account the magnitude of and the speed at which the depreciation may take place. We aim to better quantify the market ramifications based on the following hypothetical scenario:

- One-off reset for now, and moderate depreciation leading up to and post the SDR decision: Assuming the RMB doesn't significantly further depreciate by the end of this year, we believe the macro growth impact will be modest, and the ramifications will likely manifest primarily in the stock markets through the translation and transaction/ economic channels.

At the stock level, we identify stocks which may be disproportionately impacted from a few different angles and approaches:

1) GS/GH covered stocks for which our analysts see highest positive and negative earnings sensitivity to 1% of RMB depreciation vs. the USD.

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2) Export-oriented companies (not only GS covered names) which have high US revenue exposure.

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3) Stocks (not only GS covered names) which have relatively high USD-denominated debt and financial leverage.

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(ZH: And here's a look at the bigger picture based on historical episodes of depreciation):

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And by the look of it, FX carry traders are expecting more volatility to remain the norm... Last time we saw this - in 2011, it too a year for vol to normalize...

• *VOLATILITY OF YUAN FIXING COULD RISE TEMPORARILY: PBOC
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As mentioned earlier this devaluation is likely not a one-time event but rather the beginning of an ongoing and persistent depreciation of the CNY versus the USD. The embedded USD short position within the carry trades will begin to result in losses and margin calls as the USD appreciates versus the CNY, thus forcing investors to liquidate some of their positions. These trades, which took years to amass, could unwind abruptly and exert an influence of historic magnitude on markets and economies.

Charts: Bloomberg and Goldman Sachs