Yuan, Euro Rout Points to Losses in Emerging-Markets

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(Bloomberg) — Losses in the Chinese yuan and the euro have intensified in recent months, and that has increased the outlook for currencies in emerging markets in Asia and Europe.

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That’s because the yuan and euro play the role of “currency anchors” for their smaller peers, helping to prop them up or drag them down depending on prevailing market conditions. Their attachment role has become even stronger in recent months, correlational research shows.

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A rising 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 were disappointed by China’s stimulus measures, while the euro weakened as traders increased bets on an interest rate cut by the European Central Bank.

“Anytime China is under pressure from a monetary outlook or an economic outlook, that will spill over and have contagion effects across Asia,” said Brendan McKenna, an emerging markets and foreign exchange economist. Strategist at Wells Fargo Securities LLC in New York.

“If the euro comes under pressure, other eastern European currencies will probably weaken,” 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, rose to 0.95 this month, the highest level in five years. The equivalent correlation between the euro and the Bloomberg index of central and eastern European currencies rose to 0.6, from about 0.2 at the end of September. A reading of 1 will mean that both are moving in the lock position.

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The main reason for the close relationship is the strong trade connection. Exports to the euro area account for at least 50% of total exports from the CEE countries of Hungary, Poland and the Czech Republic. In emerging Asia, at least 20% of exports from South Korea, Indonesia and Malaysia go to China.

A weakening of the yuan or the euro puts downward pressure on the currencies of their export-dependent neighbors, and is often welcomed as it helps keep their goods competitive.

If the yuan falls past 7.50 per dollar, the Reserve Bank of India may allow the rupee to weaken as well, to keep the yuan-rupee cross stable, said Wim Vandenhoeck, senior portfolio manager at Invesco Ltd . New York.

The prospect of higher US prices is expected to weigh on the yuan and euro and their emerging market counterparts. Since winning the election in November, President-elect Donald Trump has threatened to impose 25% tariffs on imports from Mexico and Canada, as well as 10% additional duties on China.

“Speculation about Trump’s policies and tax threats means CEE-4 funds have a target on them,” said Anders Faergemann, head of emerging markets global fixed income at Pinebridge Investments in London, referring to the central bank. and eastern Europe.

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“We have already seen some weakness in the Hungarian area and it is always seen as a proxy in the region,” said Faergemann. “But if we see more inflation, we could see the Czech koruna bear the brunt of the euro’s weakness.”

A strong dollar

The dollar is likely to remain “strong for a long time” as well, which will put more pressure on the euro and yuan, and by extension, Asian and European currencies, according to Goldman Sachs Group Inc.

“The euro area has been hit hard by trade uncertainty and this presents a challenging environment for CEE economies and currencies,” said Kamakshya Trivedi, head of trade and interest rates at the London-based bank.

In addition, “we think it will be difficult for low-yielding Asian currencies to avoid the spillover of Chinese yuan weakness that we expect,” he said.

A Must Watch

• China’s top leaders will meet on Wednesday and Thursday for a high-profile summit, and investors will scrutinize potential comments for any clues to the 2025 stimulus plan.
• Several countries will announce inflation data this week including India, China, Mexico, Hungary, Czech Republic, Poland and South Africa.
• Brazil’s central bank is forecast to raise interest rates on Wednesday, while its Peruvian peers will announce their rate decision on Thursday.

—Courtesy of Liau Y-Sing.

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