NEW YORK (BLOOMBERG) - As bad as things are for emerging-market currencies, China is about to make them a whole lot worse.
Its devaluation of the yuan risks a new round of competitive easing that may send currencies from Brazil's real to Indonesia's rupiah tumbling by an average 30 per cent to 50 per cent in the next nine months, according to investor and former International Monetary Fund economist Stephen Jen.
Volatility measures were already signaling rising distress in emerging markets even before China's shock move. An index of anticipated price swings climbed above a rich-world gauge at the end of July, reversing the trend seen for most of the past six months.
"If this is the beginning of a new phase in Beijing's currency policy, it would be the biggest development in the currency world this year," said Mr Jen, founder of London-based hedge fund SLJ Macro Partners LLP. "The emerging-market currency weakening trend is now going global."
Latin America is a particular concern because of the region's high levels of corporate debt, said Mr Jen, who predicted the 1997 Asian crisis as a strategist at Morgan Stanley.
The yuan tumbled 1.8 per cent to close at 6.3231 per US dollar in Shanghai on Tuesday, the biggest one-day drop since China unified official and market exchange rates in January 1994.
Mr Jen recommends selling the real, rupiah and South African rand - all currencies of commodity exporters, which rely on China for a large chunk of their foreign earnings. The Bloomberg Commodity Index has dropped 11 per cent since mid-year as the world's second-largest economy suffers its sharpest slowdown since 1990.
China's move to end the yuan's de facto peg with the US dollar, and the potential for a new currency war as its trading partners react, is only the latest catalyst for declines in emerging-market currencies.
As well as the drop in raw-materials prices, the prospect of higher interest rates in the US has also drawn away investment, pushing a Bloomberg index of emerging-market exchange rates down 20 per cent in the past year. A Latin American measure headed for its 13th monthly loss out of 14, while an Asian gauge plunged on Tuesday to its lowest in six years.
China's devaluation will spark another wave of declines, said Mr David Woo, Bank of America's head of rates and foreign-exchange research in New York. The Asian nation is vital to the global economy, accounting for about 27 per cent of growth.
"This will trigger competitive devaluation around the world that will start in Asia but definitely not end in Asia," said Mr Woo, who's been predicting China would act since January.
JPMorgan Chase & Co.'s index of volatility for emerging-market currencies climbed to 9.3 per cent this week, about 0.1 percentage point higher than a Group-of-Seven measure. It rose above the developed-nation gauge on July 31 for the first time since May.
Strategists surveyed by Bloomberg anticipate declines in 19 of the 31 leading emerging-market currencies by the middle of next year, with those from Latin America and Eastern Europe seen as the biggest losers.
Morgan Stanley cautions against being too bearish. Investors betting currencies will weaken should limit their potential losses because China will follow its devaluation with fiscal-stimulus measures to boost the economy, its strategists said on Tuesday in a note.
"Asian currencies in particular should remain under pressure from the devaluation," wrote strategists including London-based head of foreign-exchange strategy Hans Redeker. "However, stops need to be tight."