By Jamie McGeever
ORLANDO, Florida (Reuters) – Japanese and Chinese monetary policies are diverging, meaning other Asian currencies could now also be at a crossroads.
Are currencies such as the South Korean won, the Indian rupee and the Indonesian rupiah based on a strengthening yen supported by expectations of a tightening of Bank of Japan policy, or on a depreciating yuan weighed down by the distress of the People’s Bank of China? to ease policies to stimulate a struggling economy?
Until recently, the yen and yuan had been joined at the hip, with both heavy selling pressure and the relentless ‘higher for longer’ Fed outlook helping the US dollar recover. But that relationship and U.S. interest rate expectations have both shifted.
Between late April and mid-July, the simple 30-day rolling correlation between the yen and the yuan steadily strengthened to its most positive level in ten months. But then it’s the other way around.
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 set at its weakest level against the dollar this year. Meanwhile, Chinese bond yields are at record lows and exchange rate pressure is firmly on the downside.
The yen, meanwhile, is up about 8% from its recent 38-year low against the dollar. The BOJ followed March’s historic rate hike – the first in 17 years – with a bigger-than-expected rate hike on Wednesday, signaling its commitment to end its decades-long use of ultra-loose policy.
Of course, Tokyo has made some $100 billion in yen-buying interventions from Tokyo in recent months, and the BOJ’s approach to raising rates is far from enthusiastic. So there is no certainty that the yen will strengthen aggressively from here.
But the policy difference with China is clear and muddies the waters for other Asian currencies.
From China’s mini-devaluation in 2015 to the start of the Federal Reserve’s recent rate hike cycle, every Asian currency was more sensitive to the dollar/yuan than to the dollar/yen, especially the won, the rupiah, the Malaysian ringgit and the Taiwan dollars. Even the Indian rupee, the Asian currency least affected by the yuan, was still three times more sensitive to moves in the Chinese currency than Japan’s.
However, as the Fed began tightening policy in 2022, Asian currencies began to be led by the extraordinary rise in the dollar/yen. According to analysts at Goldman Sachs, longer-term correlations show that the yen’s influence on the Asian currency increased dramatically when US yields began to rise.
But that correlation has faded since the Fed stopped raising rates a year ago.
“As such, the broad USD is more important to the Asian currency than to the Asian currency,” they wrote in a recent report.
So if the yuan remains 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 problems and the likely slowdown in US growth, Asian capitals may welcome weaker exchange rates rather than fear the inflationary consequences.
Beijing probably won’t be too upset if the yuan and yen start to diverge.
Since the start of the pandemic in March 2020, the Japanese currency has depreciated by about 30% against the yuan. Or to put it another way: based on simplistic exchange rates, Japanese goods at that time became 30% cheaper compared to equivalent Chinese goods on the international market.
Meanwhile, China also faces the specter of an increasingly intense trade dispute with the US. The trade war between the two countries during Donald Trump’s presidency was followed by protectionist policies from President Joe Biden’s administration, and the dark cloud of much heavier US tariffs after the November election looms.
This has all had the expected impact: according to Oxford Economics, US imports from China as a share of total imports have fallen by 8% over the period 2017-2023. However, the share of US imports from Europe, Mexico, Vietnam, Taiwan and South Korea increased. 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 trade between the US and China is offset elsewhere. A weaker yuan against its main regional rival, the yen, could help.
(The views expressed here are those of the author, a columnist for Reuters.)
(by Jamie McGeever; editing by Tomasz Janowski)
