Losses in the Chinese yuan and the euro have picked up in recent months, and that is worsening the outlook for emerging-market currencies in Asia and Europe.
That’s because the yuan and euro play a role as “currency anchors” for their smaller peers, helping to either support them or drag them down depending on the prevailing market conditions. Their anchor role has become even stronger in recent months, a study of correlations shows.
A surging US dollar and the threat of higher US tariffs have dragged down the yuan and euro since the end of September. The yuan also weakened as traders grew disappointed over China’s stimulus measures, while the euro was pummelled as traders boosted bets on European Central Bank interest-rate cuts.
“Anytime China is either coming under pressure from a currency perspective or more an economic perspective, that’s going to spill over and there’s going to be contagion effects for the rest of Asia,” said Brendan McKenna, an emerging-markets economist and foreign-exchange strategist at Wells Fargo Securities in New York.
“If the euro’s coming under pressure, some of the eastern European currencies are probably going to weaken as well,” he said.
The 30-day correlation between the yuan and the Bloomberg Asia Dollar Index, which tracks a basket of emerging currencies in the region, climbed to 0.95 this month, the highest level in five years. An equivalent correlation between the euro and a Bloomberg index for central and eastern European (CEE) currencies rose to 0.6, from around 0.2 at the end of September. A reading of 1 would mean the two move in lockstep.
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A major reason behind the close correlations is the strong trade linkages. Exports to the eurozone make up at least 50 per cent of total shipments from the CEE countries of Hungary, Poland and the Czech Republic. In emerging Asia, at least 20 per cent of exports from South Korea, Indonesia and Malaysia go to China.
A weakening of the yuan or euro puts downward pressure on the currencies of their export-dependent neighbours, and can be often be welcomed as it helps keep their goods competitive.
If the yuan depreciates past 7.50 per US dollar, the Reserve Bank of India may let the rupee weaken as well, so as to keep the yuan-rupee cross stable, said Wim Vandenhoeck, a senior portfolio manager at Invesco in New York.
The prospect of higher US tariffs is set to further weigh on the yuan and euro and their emerging-market counterparts. Since his election victory in November, president-elect Donald Trump has threatened to slap 25 per cent tariffs on imports from Mexico and Canada, and an additional 10 per cent duties on China.
“Speculation around Trump’s policies and the tariff threats mean the CEE-4 currencies do have a target painted on them,” said Anders Faergemann, co-head of emerging markets global fixed income at Pinebridge Investments in London, referring to the main currencies of central and eastern Europe.
“We’ve already seen some weakness in the Hungarian forint and it’s always seen as a proxy to the region,” Faergemann said. “But if we do see additional tariffs, we can see the Czech koruna bearing the brunt of the euro’s weakness.”
Stronger US dollar
The US dollar is likely to remain “stronger for longer” too, which will put further pressure on the euro and yuan, and by extension, the currencies of emerging Asia and Europe, according to Goldman Sachs Group.
“The euro area is particularly negatively impacted by trade uncertainty and this presents a challenging environment for the CEE economies and currencies,” said Kamakshya Trivedi, head of global foreign-exchange and interest rates at the bank in London.
In addition, “we think it will be hard for Asia low-yielder currencies to avoid spillovers from the Chinese yuan weakness that we expect”, he said. BLOOMBERG
