Will China’s Currency Devaluation Reverse Luxury Gains?

This week, ongoing U.S.-China trade tensions entered a more aggressive phase as China allowed the value of the yuan to drop 2 percent against the dollar, falling to its lowest level since April 2008. This devaluation comes, according to Beijing, as a response to last week’s announcement by U.S. President Trump of a 10 percent tariff to take effect September 1 on a further $300 billion in goods coming from China.

As Nicole Tanenbaum of Chequers Financial Management told Fortune this week, “Allowing the yuan to weaken makes Chinese imports into the United States less expensive, effectively offsetting the impact of the tariffs, and making U.S. companies less competitive,” adding that a “weak yuan will help boost China’s exports while hurting foreign competition.”

The ongoing tit-for-tat moves have many worried that the trade dispute is venturing into currency war territory — and luxury brands should be concerned.

So far this year, most major luxury brands have seen mixed-to-positive results in the Greater China region, with weakness in Hong Kong and Macau offset somewhat by signs that Chinese shoppers are spending more at home. However, Chinese tourist-shoppers also continue to spend in popular destinations like Europe, while North American retailers expect less spending due to fewer arrivals. Regardless of where they’re doing it, luxury enthusiasts continue to buy.

The latest currency devaluation quickly caused shockwaves among major brands, already worried that the falling yuan will join a slowing Chinese economy in leading to a decline in Chinese consumer purchasing power. The knock-down effect could mean luxury brands will need to increase prices in China, something that few likely want to do having moved to harmonize prices there last year to boost purchases at domestic Chinese stores.

Kering Stocks — which recorded positive first-half 2019 results last month driven in large part by China — took a 1.9 percent hit in the wake of the currency devaluation news, while L’Oréal (which has invested very heavily in China over the past decade) shares fell 3.1 percent and LVMH dropped 4.2 percent.

If history is any guide, the currency devaluation will cause short-term pain for any luxury brand operating in the Greater China market and could cause lasting damage depending on how long the ongoing trade dispute rages. Back in 2015, a similar move to drop the value of the yuan by 2 percent caused luxury stocks to slide and led many brands to retool their China strategy and focus more on catering to outbound Chinese tourist-shoppers. (Then a fast-growing segment in markets like Western Europe and the United States, but one that now could be more averse to spending with a weaker yuan.)

This time, however, the damage for luxury brands could be even more widespread than four years ago, given a litany of other factors not present at that time, such as a far more contentious U.S.-China relationship (which will limit the number of Chinese tourist arrivals and thus purchases in the United States this year), a slowing Chinese economy, which will lead some consumers to make fewer high-end purchases anyway, and weaker demand for trips to (and shopping in) a tense Hong Kong.

Perhaps the biggest concern for luxury brands is whether the yuan will weaken even further in the remainder of 2019. Oanda market strategist Edward Moya told the BBC that continued yuan depreciation “should be expected,” and we could “see another 5 percent before the end of the year.” Capital Economics expects the yuan to sit at 7.30 per US dollar by end of year, compared to previous forecasts of 6.90. If this all pans out, luxury groups and brands should expect a much tougher tough road ahead.

While super-rich shoppers, more insulated from currency fluctuations or pricing than middle-class customers, may continue to shop, they may buy less. Meanwhile, those customers more sensitive to pricing will likely buy fewer latest-collection items or accessories and may opt for more second-hand products instead.

If further depreciation is in the cards and the trade dispute continues to gain pace, recent cautious optimism about China market revenue in the second half of 2019 among the likes of Kering and LVMH may have been premature. Now, unfortunately, they’re stuck with a wait-and-see scenario before they can decide how to mitigate the damage and keep revenue from nosediving among what is arguably their most crucial consumer base. No matter what, it doesn’t look pretty for the foreseeable future.

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