Harish Sridharan and Tom Westbrook

SINGAPORE/BENGALURU – Markets have been resigned to the fact that the’s nadir from a high of nearly four years has signaled that a period of relative stability may be ending. This would leave regional counterparts exposed as U.S. Interest rates rise.

A stable yuan along with strong exports and currency reserve have protected Asia’s emerging markets against the kind of exodus usually seen when interest rates rise in developed countries.

The yuan outlook has been ill for many years, with China’s slowing economy and policy easing.

Claudio Piron (co-head Asia fixed income, FX) at Bofa Securities Singapore stated that “the yuan played an important role in stabilising Asian currency in 2021 and even exceeded the dollar.”

However, the impact of policy headwinds will likely drag it down by 5% to $6.70 per Dollar this year.

“This depreciation of the yuan will cause a negative spillover to Asian currencies, particularly South Korean wons and Taiwan dollars.”

The yuan has seen volatility return already. On Jan. 27, it saw its sharpest drop against the dollar in seven month. At 6.36 dollars per dollar, the yuan has remained flat so far this year.

The long-running rally in Taiwan’s dollar also stopped. South Korean won has been trending down and is under increasing pressure.

Ken Peng (head of Asia Investment Strategy at Citi Private Bank, Hong Kong) stated that the reasons for supporting the yuan in spite of a weak economy have waned.

He said that bond inflows had already declined sharply since the positive carry vanished, and that the trade surplus would likely fall from records, making the yuan more vulnerable to falling to 6.50 dollars this year.

Although foreign Chinese bonds have risen to an all-time high of nearly $400 billion, flow has been slower as the gap in yields between Chinese 10-year and U.S. 10-years almost doubled since December.

FUNDS RETREAT

A stable yuan is a symbol of a Chinese economy’s strength, according to analysts. It is considered a plus for Asian exporters as it reduces the urgent need for competitive currency devaluation.

China’s central banking has pledged to maintain the currency stability, however authorities stress the necessity to be prepared for two-way volatility. Analysts anticipate that the U.S. will experience increased interest rates and downward pressure.

Prior bouts of weakness such as the devaluation in support of the economy in 2015, or the slide in 2018 due to trade tensions, have often led to currency pressure, including the Thai Baht, Malaysian Ringgit, Indonesian Rupiah, and Singapore Dollar.

Mitul Kotecha from TD Securities, Singapore’s emerging markets strategist, said, “If the yuan is more volatile, it could likely result in lower foreign flows into China and likely affect overall flows to Asia.”

As China tightens its outbound capital controls, he doesn’t expect another regional contagion. However, he said that while China has not increased their foreign-flow restrictions, he believes there will be no repeat of 2015’s outbreak.

Since then, the yuan seems to have stopped falling rather than rallying. The more risky parts of the region such as Indonesia are far better off than the emerging market walloping that occurred in 2013, when it fell 17% in just five months.

Citi’s Peng believes domestic factors are more important than the yuan’s drag, and BofA’s Piron feels that a Chinese economic revival can provide some support. Asian economies that have faster growth are also more resilient to inflation.

However, pressures could quickly mount if the Federal Reserve raises rates as fast as futures market imply. Data suggests that foreign equity investors have already spent the last month voting.

The largest outflows of Asia from January were seen in six months. This was due to $4.4 billion outflows into Indian stocks.