No Revaluation for Retail

But if China sells a lot of dollars, interest rates could be a problem in the U.S.
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Politicians gave the surprise revaluation of the Chinese yuan a warm welcome Thursday, but U.S. retailers, which have long thrived on importing cheap Chinese consumer goods, played it cool.

China signaled a first step toward currency deregulation by unhitching the yuan from the dollar and agreeing to set the currency's value according to a basket of its foreign counterparts. The move came after months of political and market pressure, particularly in the U.S. where leaders have complained that a low yuan gave Chinese exporters an unfair advantage.

"I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said in a statement. "As we have said, reform of China's currency regime is important for China and the international financial system."

While this development was being viewed as a symbolic step for China in its continued embrace of the free market, the actual change in valuation was negligible. U.S. retailers expressed little concern about their low-cost business models that are largely based on Chinese imports.

"This is relatively insignificant as far as a retailer like

Wal-Mart

(WMT) - Get Report

is concerned," says Mark Miller, a retail analyst William Blair & Co. "The fundamental driver for the low prices for Chinese goods is the large pool of labor that still needs to be absorbed by the Chinese economy. There's still a tremendous reservoir of workers over there, so I think Chinese producers can remain very aggressive on prices compared to U.S. producers."

Previously, Beijing pegged its currency to a rate of 8.27 per dollar to ensure stability in its volatile, fast-growing economy. The new rate will initially be 8.11 yuan per dollar, amounting to a 2.1% revaluation. That falls well short of the 10% revaluation that politicians in Washington were seeking.

"A move like this has been widely anticipated by U.S. retailers, and I don't think it will cause any significant changes in valuations or expectations on Wall Street," Miller says. "Remember, China is not the only low-cost exporter that retailers can turn to."

Low-cost foreign goods pour into the U.S. from all over Asia and other places like Latin America and Africa. However, China plays a dominant role in many markets. For instance, imports from China make up an estimated 70% of the U.S. athletic and leather footwear market. It also makes up a major chunk of the goods in the U.S. apparel industry.

Despite such reassurances, shares of major retailers showed declines shortly after the announcement from China. Shares of Wal-Mart were recently down 75 cents, or 1.5%, to $49.25; shares of

Target

(TGT) - Get Report

dropped $1.42, or 2.4%, to $58.56; and shares of

Sears Holdings

(SHLD)

were down $3.38, or 2.1%, to $159.73.

Meanwhile, specialty retailers that import apparel goods from China were also lower. Shares of

American Eagle Outfitters

(AEOS)

traded down 58 cents, or 2.1%, to $32.30; shares of

Aeropostale

(ARO)

shed 62 cents, or 1.9%, to $31.46; and

Pacific Sunwear

(PSUN)

was down 33 cents, or 1.4%, to $22.43.

The major market indices were also trading lower by less than 1% amid reports of more terrorist-related turmoil in London, so reactions to the announcement from China were difficult to gauge accurately.

Bernstein & Co. analyst Emme Kozloff says China's revaluation will not have a material effect on the margins of major retailers. She wrote in a research note that "the greater impact for retail investors to consider is the pressure on interest rates and implications for U.S. consumer spending."

In its announcement Thursday, the Chinese central bank signaled it would move toward setting to value of the yuan based on a trade-weighted basket of foreign currencies. Kozloff says she thinks the basket will include the euro and yen along with the dollar, which implies less demand for the greenback in currency markets. That, Kozloff says, could put pressure on interest rates, which might crimp U.S. consumer spending.

Morgan Stanley economist Stephen Roach echoed this point in a research note.

"A basket now allows China to begin diversifying its foreign exchange reserves out of their extreme overweight positions in dollar-denominated assets," Roach wrote. "This may be a diversification signal for other Asian central banks (especially Korea), who have been chomping at the bit to do the same."

John Williamson, a senior fellow with the Institute for International Economics, said such an event is unlikely.

"The U.S. dollar will remain the most convenient currency for the Chinese and others to buy, even if their currency is floating with a wider variety of currencies," Williamson says.