Until recently, the yen and yuan had been joined at the hip. — Reuters
JAPANESE and Chinese monetary policy is diverging, meaning other Asian currencies may now also be at a crossroads.
Do currencies, such as the South Korean won, Indian rupee and Indonesian rupiah take their cue from a firming yen being supported by expectations of policy tightening from the Bank of Japan (BoJ), or from a depreciating yuan being weighed down by the People’s Bank of China’s (PBoC) need to ease policy to stimulate a struggling economy?
Until recently, the yen and yuan had been joined at the hip, with both under heavy selling pressure as a relentless ‘higher for longer’ Federal Reserve outlook caused the US dollar to rally. But that relationship and US rate expectations have both shifted.
Between late April and mid-July, the simple 30-day rolling correlation between the yen and yuan steadily strengthened to its most positive level in 10 months. But it has subsequently reversed.
This is largely because the PBoC surprised markets last week by cutting key interest rates.
And this week the yuan, which is tightly controlled by the central bank, was fixed at the weakest level against the dollar this year. Meanwhile, Chinese bond yields are at record lows, and pressure on the exchange rate is firmly to the downside.
The yen, meanwhile, has jumped some 8% from its recent 38-year low against the dollar.
The BoJ followed up March’s historic rate hike – the first in 17 years – with a larger-than-expected increase on Wednesday and signalled its commitment to end its decades-long use of ultra-loose policy.
Of course, around US$100bil of yen-buying intervention from Tokyo in the last few months has put a floor under the currency, and the BoJ’s approach to raising rates is hardly gung-ho.
So the yen is not a sure-fire bet to strengthen aggressively from here.
But the policy divergence with China is clear, and it’s muddying the waters for other Asian currencies.
From China’s mini-devaluation in 2015 to the beginning of the Federal Reserve’s (Fed) recent rate-hiking cycle, every Asian currency was more sensitive to dollar and yuan than dollar and yen, especially the won, rupiah, Malaysian ringgit and Taiwanese dollar.
Even India’s rupee, the Asian currency least influenced by the yuan, was still three times more sensitive to moves in China’s currency than Japan’s.
However, once the Fed started tightening policy in 2022, Asian currencies began to be led mostly by the extraordinary rise in dollar and yen.
According to analysts at Goldman Sachs, longer-term correlations show that the yen’s influence on Asian currencies surged dramatically when US rates started rising.
But that correlation has faded since the Fed stopped hiking a year ago.
“As such, the broad dollar and dollar and yuan matters more for Asian foreign exchange (forex) than dollar and yen,” they wrote in a recent report.
So if the yuan stays weak, Asian currencies could remain on the soft side even as a Fed easing cycle weighs on the dollar.
That’s probably not bad news – given China’s economic struggles and the likely slowdown in US growth, Asian capitals may welcome weaker exchange rates more than they fear the inflationary consequences.
Beijing likely won’t be too upset if the yuan and yen diverge.
Since the onset of the pandemic in March 2020, Japan’s currency has depreciated around 30% against the yuan. Or to put it another way, on a simplistic exchange rate basis, Japanese goods became 30% cheaper over that time compared with equivalent Chinese goods on the international market.
Meanwhile, China is also facing the spectre of an intensifying trade dispute with the United States.
The trade war between the two countries during Donald Trump’s presidency was followed by protectionist policies of President Joe Biden’s administration, and the dark cloud of much heavier US tariffs after November’s election is looming.
This has all had the expected impact: US imports from China as a share of its total imports fell by 8% over the 2017 to 2023 period, according to Oxford Economics.
However, the share of US imports from Europe, Mexico, Vietnam, Taiwan and South Korea rose.
Meanwhile, these countries – especially Vietnam – all saw imports from China rise as a share of their total imports over the same period.
Beijing will want to ensure that any deterioration in bilateral US and China trade continues to be made up for elsewhere.
A weaker yuan, relative to its main regional rival the yen, might help. — Reuters
Jamie McGeever is a columnist for Reuters. The views expressed here are the writer’s own.
