- China appears to be preparing to offset the impact of Donald Trump’s new US trade war tariffs, increasing fears of regional currency declines and further equity exodus
- On September 1, the US is set to implement the first phase of a 10 per cent tariff on a wide range of Chinese manufactured consumer goods worth around US$130 billion
The value of the Chinese yuan fell to a fresh 11-year low against the US dollar on Friday, fuelling worries that China has given up on achieving any progress to end the trade war with the United States in the near term and so is moving to offset the effect of new tariffs with a weaker exchange rate.
The weaker yuan, in turn, dragged down regional currencies, aided by central bank interest rate cuts, that would lead to an acceleration of capital outflows from Asia this year.
Recent signs appear to indicate that China was preparing its economy for a scenario in which no progress is made at the face-to-face trade negotiations between US and Chinese officials expected to take place in Washington next month, analysts said.
And despite the US labelling China a currency manipulator early this month to address what it sees as the unfair trade advantage resulting from a cheaper yuan, Chinese authorities let the yuan drop to its weakest level since March 2018, the seventh straight daily decline.
The drop in the yuan followed a reduction in interest rates by the People's Bank of China (PBOC) this week. The central bank set its new one-year lending prime rate at 4.25 per cent, down from the old lending benchmark rate of 4.35 per cent, which analysts believe is the start of an easing cycle to prop up economic growth.
"Perhaps the PBOC is sending a message to the US trade hawks that it will let the yuan gradually weaken as a policy weapon to neutralise the effect of increased tariffs," said Stephen Innes, co-founder of Valour Markets.
On September 1, the US is poised to implement the first phase of a new 10 per cent tariff on a wide range of Chinese manufactured consumer goods worth around US$130 billion, bringing US-China bilateral relations to a new low, the Economist Intelligence Unit warned, so businesses should prepare for a prolonged conflict and be aware that the trade war could escalate in other ways.
The weaker yuan and prospects that other Asian currencies would follow, could exacerbate the sharp increase in capital outflows from Asia already underway, analysts warned.
Perhaps the PBOC is sending a message to the US trade hawks that it will let the yuan gradually weaken as a policy weapon to neutralise the effect of increased tariffsStephen Innes
Money has been fleeing stock markets almost across the entire Asian region this month, a trend that could worsen during the rest of the year, said Irene Cheung, ANZ Bank's senior Asia strategist. Taiwan has seen equity outflows of US$2.4 billion so far this month, South Korea US$1.9 billion and Thailand US$1.6 billion, Cheung said.
While some Asian bond markets were attracting inflows because Asian issues still provide positive investment returns compared to the negative yields offered in Europe and Japan, the inflows were not big enough to completely outweigh equity outflows from the region, Cheung said,
"Investors are avoiding equities because of risk aversion. But we do see some bond inflows because the fixed income market is a place to go to when the economic outlook is negative," Cheung said.
Given the worsening outlook for global growth and the escalating trade war between China and the US, a wave of rate cuts in a number of countries across the world have been exerting downward pressure on their currencies.
The US Federal Reserve, as well as the central banks from Australia, New Zealand, Thailand and the Philippines, have all cut rates in the last month. On Thursday, the central bank of Indonesia cut its benchmark interest rate for the second consecutive month despite the recent weakness of the rupiah exchange rate.
In Hong Kong, the foreign exchange market has been showing mounting fears of massive capital flight from the city in the future. Forward contracts, which bet on a currency's value at particular point in the future, rose to their highest level since 2016, reflecting belief that the Hong Kong dollar would weaken below the key level of 7.85 per US dollar in a year's time.
The Hong Kong dollar was pegged at 7.80 to the US dollar in 1983, with a trading band of 7.75 and 7.85 introduced in 2005. On Friday, the Hong Kong Monetary Authority said that even though Hong Kong dollar forwards had fallen below the 7.85 level, that would not diminish the effectiveness of the city's linked exchange rate regime.
"There seems to be a new wave of depreciation pressure in the region given that the leading currency (,the yuan,) is falling," said Ken Cheung Kin-tai, chief Asian currency strategist. "Expectations that central banks would keep cutting rates are also keeping the currencies weak."
Jason Lui, head of equity and derivative strategy at the Hong Kong branch of BNP Paribas, said Chinese investors were not abandoning Hong Kong's stocks, even as Asia's third-largest equity market endures a double whammy of social upheaval and jitters about a global recession.
There seems to be a new wave of depreciation pressure in the region given that the leading currency (,the yuan,) is fallingKen Cheung Kin-tai
So far China's investors have been piling into Hong Kong shares via the Stock Connect channel in the longest shopping spree in 18 months, Lui said.
Funds from mainland China helped Hong Kong's capital market weather the turmoil in the global financial markets during the yuan devaluation in 2015 and amid heavy international betting on yuan depreciation in 1998, when the city faced down hedge fund tycoon George Soros with an unprecedented HK$118 billion (US$15 billion) stock-buying spree to prop up equity prices and defend the currency peg.
Gene Ma, head of China Research at Institute of International Finance, forecast capital outflows of US$150 billion from China this year, up from US$30 billion in 2018, but much smaller than the US$647 billion in 2015.
Outflow pressure from Chinese residents has been persistent, as US tariffs have encouraged both Chinese and foreign manufacturers to relocate their factories outside of Chinese, damping foreign direct investment into the country, Ma said.
Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.
