Yuan's fall sparks fears of contagion

The yuan's drop in the past two weeks has coincided with an escalation in trade tensions with the US, spurring concern that China might embrace purposeful devaluation as a policy tool.
The yuan's drop in the past two weeks has coincided with an escalation in trade tensions with the US, spurring concern that China might embrace purposeful devaluation as a policy tool.PHOTO: AGENCE FRANCE-PRESSE

HONG KONG • Global investors might shrug at a bear market in Chinese domestic stocks - largely walled off from the rest of the world. But a tumble in the yuan that has blindsided currency forecasters is now triggering warnings of potential contagion.

At one point yesterday, the yuan was down more than 0.5 per cent against the US dollar for a third straight day, an unusually sharp move for the managed currency. Such a magnitude had not been seen in a short stretch since China's August 2015 devaluation, when the currency slid 2.8 per cent over two days. The yuan stood at 6.5954 per US dollar as of 4pm in Shanghai.

"I expect the yuan to head back toward 6.70 or 6.80," said Mr Greg McKenna, a former currency strategist with Australian banks. "I wonder if that will spook developed markets in a way the fall in Chinese stocks hasn't? I think it might."

The yuan has tumbled about 3 per cent in the past two weeks. While that's left it only at its weakest since December, the drop has coincided with an escalation in trade tensions with the US, spurring concern that China might embrace purposeful devaluation as a policy tool. Surging interest saw yuan options trading rise to the third-most traded globally on Tuesday. A more typical day would see it from seventh to tenth place; it was on top yesterday in Asia.

Depreciating the yuan is one of the two most likely options for China to consider in response to any move by the US to impose a 10 per cent tariff hike on US$200 billion or more of Chinese imports, said Mr Alex Wolf, senior emerging markets economist in Hong Kong at Aberdeen Standard Investments.

There are reasons for Chinese authorities to prevent sustained weakening in the yuan - including promoting the currency as a rival to the US dollar and its use in commerce with trading partners, said Mr John Hardy, head of foreign-exchange strategy at Saxo Bank.

"So I would be surprised, in other words, if the recent pace of weakening is sustained for much longer."

Asked why he thought the yuan was weakening, he said it "could be domestic economic risks, and sending a warning - or simply that the recent yuan appreciation (in basket terms) has proceeded far enough - or all three."

Depreciating the yuan is one of the two most likely options for China to consider in response to any move by the US to impose a 10 per cent tariff hike on US$200 billion (S$273 billion) or more of Chinese imports, said Mr Alex Wolf, senior emerging markets economist in Hong Kong at Aberdeen Standard Investments.

"A 10 per cent depreciation could offset the additional tariffs at a 10 per cent rate, although not without significant risks, including exacerbating outflows," Mr Wolf wrote in a note to clients on Tuesday.

"There are no costless options, but hopefully we don't reach that point."

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on June 28, 2018, with the headline 'Yuan's fall sparks fears of contagion'. Print Edition | Subscribe