Dollar-Plagued World Now Has Another Currency to Worry About

Winds of change in currency markets threaten to blow global investment trends further off course -- but from the East as much as the West.

While investors have been focused on a strengthening U.S. dollar and rising Treasury yields, a weaker Chinese yuan also threatens to heap pressure on emerging market assets that have already wiped out their gains for the year.

That’s because a pause in the yuan’s appreciation path would challenge a clutch of developing economies by hitting their trade competitiveness against China, according to Morgan Stanley.

“RMB up and USD down is the best world in which you can live,” said Hans Redeker, the bank’s London-based chief global currency strategist. “You have it easier on exports and funding, all at the same time.”

The surge in the trade-weighted yuan last year boosted the competitiveness of China’s rivals offering similar goods and services in international markets, particularly those in Southeast Asia. Meanwhile, the depreciating dollar made it cheaper to service foreign debts in local-currency terms.

Now, there’s a change in market sentiment, underscored by a shift in projections on how the People’s Bank of China will set the daily fixing of the yuan. After an extended run where sell-side analysts predicted a stronger rate than delivered, some eight strategists and traders told Bloomberg News this week they foresee a depreciating bias, citing the central bank’s likely preference for a weaker currency.

The yuan has fallen about 1.2 percent since the start of April thanks to the rebound in the greenback, after the biggest quarterly advance in a decade in the three months through March. Meanwhile, one of the most accurate forecasters on the Chinese currency last year, as tracked by Bloomberg News, ended his bullish stance last month, citing the brewing trade war with the U.S.

For emerging-markets bulls, there is still hope. The dollar’s recent rebound is a cyclical blip in a bear market, and China will likely pause the yuan’s appreciation path rather than reversing it, according to Redeker. “It needs a higher RMB to support consumption over investment.”

— With assistance by Luke Kawa