Weaker yuan could rock emerging and developed markets alike, strategists warn

China watchers calling for Beijing to loosen its grip on the yuan need to be mindful of the risk that it unleashes a chain reaction rocking emerging- and developed-market currencies alike, according to some strategists.

Most under threat are currencies of Asian neighbours such as South Korea and Thailand, where China is the biggest trading partner. But a suddenly weaker yuan may have a much wider impact, turbocharging renewed strength in the US dollar, the traditional wrecking ball for developing nations’ currency markets.

China’s managed currency is seen as an anchor for its regional peers, meaning small moves can have an outsize impact.

Last month, a weaker-thanbefore daily reference rate triggered a slide that pulled down Asian currencies, spilled over to developed names as diverse as the Swedish krona and the Canadian dollar, and bolstered havens like the yen and the Swiss franc.

“We’ve gone through a period of exceptional, policy-driven stability for the yuan,” said Themistoklis Fiotakis, head of currency strategy at Barclays.

That is unlikely to last as the “fundamentals point to the fact that the yuan should be weaker, the dollar should be stronger and volatility should be stronger”.

Danger signals are appearing that the yuan may be set to resume its slide after four months of relative stability. Aside from the impact of that surprise daily reference rate, pressure looks to be growing with the yuan ominously close to the edge of its fixed trading range against the dollar, a level around which authorities have pushed back with aggressive measures in the past.

The People’s Bank of China has plenty of tools available to it to support the yuan, from direct intervention to creating a dramatic liquidity squeeze in the offshore market, and has shown little intention it wants anything more than currency stability.

It stepped in to bolster the yuan again yesterday with a record fixing level relative to estimates after a fresh round of hot US inflation propelled the dollar higher against global peers.

Still, traders will remember the shock yuan devaluation in 2015, which sparked a chain reaction across global markets, sending stocks, emerging-market assets and commodities tumbling.

Robust US economic data is damping bets on Federal Reserve interest rate cuts and bolstering the dollar. That, coupled with China’s gloomy growth outlook, is putting policymakers in a bind: either they do more to underpin the currency and risk damaging the economy, or tolerate weakness and accept potential capital outflows.

If the yuan is allowed to weaken, the reverberations are likely to be strongest in Asia. The region’s two worst-performing emerging currencies this year, the Korean won and the Thai baht, may be at forefront of further declines, with those of Indonesia and India perhaps less vulnerable as they are already being bolstered by authorities.

Central banks in Asia are likely to take much of their guidance from Beijing in their currency management, according to Wang Ju, head of Greater China foreignexchange and rate strategy at BNP Paribas in Hong Kong. With officials keeping an iron grip on the yuan and the yen also trading in a very tight range, pressure is building on the two big currency drivers in the region.

“If one of the big names lets go of their currency, the range will break and market volatility will surge,” Wang said. Asian central banks may be forced to rethink whether to “move their ranges higher to accommodate the volatility”.

A resurgent US dollar is already exasperating central bankers and governments around the world, forcing them into action to relieve the pressure on their currencies.

For Paul Mackel, global head of currency research at HSBC, a wider risk is as the yuan weakens, this dollar strength becomes even more pronounced, thanks to China’s extensive trade linkages.

“You shift from just a strong dollar to an even stronger dollar because the risk is to a broader base,” Mackel said in Hong Kong.

If one of the big names lets go of their currency ... market volatility will surge WANG JU, BNP PARIBAS