The recent selloff in global markets has been largely associatedwith the what's going on in China (theyuan devaluation, the Shanghai Composite plunge, theslowing growth). But Deutsche Bank's FX Strategist George Saravelospinpoints Chinese “quantitative tightening” as the key factor towatch.

Here's Saravelos explaining that, basically, China built upreserves just like the Fed did in recent years, and the world hasto contend with that reversal:

Why have global markets reacted so violently to Chinesedevelopments over the last two weeks? There is a strong case to bemade that it is neither the sell-off in Chinese stocks nor weaknessin the currency that matters the most. Instead, it is what ishappening to China's FX reserves and what this means for globalliquidity. Starting in 2003, China engaged in an unprecedentedreserve-accumulation exercise buying almost 4trio of foreignassets, or more than all of the Fed's QE program's combined. Theglobal impact was indeed equivalent to QE: The PBoC printeddomestic money and used the liquidity to buy foreign bonds.Treasury yields stayed low, curves were flat, and people called itthe “bond conundrum.”

Turn the clock forward to today, and he says things have changedrather quickly.

The sudden shift in currency policy has prompted a big shift inRMB expectations towards further weakness and correspondingly ahuge rise in China capital outflows, estimated by some to be asmuch as 200bn USD this month alone. In response, the PBoC has beendefending the renminbi, selling FX reserves and reducing itsownership of global fixed income assets. The PBoC's actions areequivalent to an unwind of QE, or in other words QuantitativeTightening (QT).

This fits nicely with the latest news about Chinaselling U.S. Treasuries to raise the dollars needed to support theyuan's devaluation.

This change in direction isn't over, and Saravelosconcludes: ”… it is hard to become very optimistic on globalrisk appetite until a solution is found to China's evolvingQT.”

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.