China devaluation hits stocks, boosts U.S. dollar on currency war fears

By David Gaffen

NEW YORK (Reuters) - China's 2.0 percent devaluation of the yuan on Tuesday pushed the U.S. dollar higher and hit equity markets worldwide as it raised the prospect of a new round of currency wars and fed worries about slowing Chinese economic growth.

Stocks fell in Asia, Europe and the Americas, as investors worried about the implications of a move designed to support China's slowing economy and exports. The MSCI All World Index of global shares fell 0.7 percent.

"What is good for growth in China is unfortunately bad for everybody else," said Bill McQuaker, co-head of multi-asset at Henderson Global Investors.

The Dow Jones industrial average fell 137.33 points, or 0.78 percent, to 17,477.84, the S&P 500 lost 11.74 points, or 0.56 percent, to 2,092.44 and the Nasdaq Composite dropped 20.10 points, or 0.39 percent, to 5,081.70.

The devaluation especially hit the stock prices companies exposed to China, with shares of U.S. heavy equipment maker Caterpillar losing 2.3 percent and Germany's Volkswagen dropping 4.6 percent.

European shares fell. The pan-European FTSEurofirst 300 index was down 1 percent, led lower by car makers and luxury goods companies, whose products have just got more expensive for Chinese consumers.

Against the trend, shares in Athens, however, gained 1.5 percent after the country secured a third bailout deal with creditors, making it the only European bourse to rise.

On Chinese stock markets, airlines and importers fell, though exporters rose. The CSI300 index of the largest listed companies in Shanghai and Shenzhen lost 0.4 percent and the Shanghai Composite closed flat.

BIGGEST FALL IN YUAN SINCE 1994

China's move, which the central bank described as a "one-off depreciation" based on a new way of managing the exchange rate that better reflected market forces, triggered the yuan's biggest fall since 1994, pushing it to its weakest against the U.S. dollar in almost three years.

In a potentially worrisome sign, China's offshore yuan, a more liquid instrument traded out of Hong Kong, fell 2.9 percent, exceeding the fall in the onshore yuan. It suggests more possible losses for the onshore currency, as the Hong Kong-traded yuan tends to act as a precursor to the onshore.

Emerging market currencies which have already fallen sharply in the past year as the US dollar has strengthened, slumped again on Tuesday.

The Malaysian ringgit and the Indonesian rupiah hit lows not seen since the Asian financial crisis 17 years ago while the U.S. dollar gained 2.0 percent against Brazil's real, putting it in range of levels not seen since 2003.

The Australian dollar, often used as a liquid proxy for the yuan, fell 1.2 percent to $0.7322. Investors who had held euro-funded yuan positions bought back the single currency, pushing it up 0.2 percent to $1.1042.

The weakness in stocks boosted top-rated bonds. German 10-year yields fell 5 basis points to 0.64 percent and U.S. equivalents dropped 6 bps to 2.16 percent.

The devaluation also rippled through commodity markets, driving crude oil prices down after Monday's hefty gains and pushing copper futures to a fresh six-year low.

Oil prices fell as dollar-priced commodities became more expensive, weighing on demand. Brent crude was down 2.7 percent to $49.03. [O/R] Copper futures lost 2.9 percent to $5156.50 per tonne.

Gold fell to as low as $1,093.25 before recovering to around $1,105 an ounce.

CURRENCY WARS?

The big question now for emerging markets, where economic growth has slowed and capital flight has increased, is whether their officials respond to China's move in kind.

"The key will be the response of other central banks ... There should be further pressure on the currencies of China's trade partners," said Nick Lawson, managing director at Deutsche Bank in London.

The U.S. government has for years pressed Beijing to liberalize its control of the yuan to allow it to strengthen given China's high rate of economic growth and massive exports.

But Chinese economic growth rate is now slowing and the new exchange rate mechanism gives markets greater ability to push the yuan lower, just as the United States prepares to raise interest rates, a step that may add further to U.S. dollar strength.

Investors are now wondering whether China's devaluation will keep the Federal Reserve from raising rates in September as many anticipate.

(Additional reporting by Jemima Kelly, Marius Zaharia, Sudip Kar-Gupta and Clara Denina in London; Editing by Susan Fenton and Clive McKeef)