Emerging markets at mercy of falling yuan as currency war looms

China’s yuan is back at the top of emerging-market investor worries as the deepening standoff between the U.S. and China over trade threatens to evolve into a currency battle.
As the dollar strengthens amid the trade tensions, the slide in the yuan is spurring concern that China might be embracing purposeful devaluation as a policy tool. That stoked the ire of US President Donald Trump, who accused the country and the European Union of manipulating their currencies. The offshore yuan’s one-week implied volatility jumped to a five-month high.
“The yuan’s definitely weighing on risk, although much more so on Asia,” said Edwin Gutierrez, the London-based head of emerging-market sovereign debt at Aberdeen Standard Investments. “But we are confident that the Chinese will not let things get disorderly. Having recently won the battle against capital outflows, they’re not about to stoke those again by letting the currency depreciate significantly.”
The People’s Bank of China last week fixed the currency past 6.7 per dollar for the first time in almost a year and on Friday weakened the reference rate the most in two years. A further drop in the yuan to 7 against the dollar may trigger another round of panic selling in emerging markets, Gutierrez said. The currency regained some ground on Friday after a big Chinese bank sold dollars, traders said.
Asian currencies, including the South Korean won and Indonesian rupiah, have born the brunt of the sell-off in emerging markets this month, with the yuan the worst performer after Turkey’s lira.
The Argentine and Mexican peso as well as Brazil’s real have been the top-performing developing-nation currencies this month. Aberdeen Standard has been overweight Latin American currencies “for quite a while,” Gutierrez said. — Bloomberg