Asian stocks on the rise as China yuan recedes

The Chinese yuan's recoil from a near four-year high has raised market nerves that a recent period of stability is ending, which could leave regional peers exposed, especially as U.S. interest rates start to rise.

A steady yuan, coupled with robust exports and currency reserves, has helped shield Asia's emerging markets from the sort of exodus typically seen when developed market interest rates rise.

Slowing economic momentum and policy easing in China, despite expectations for as many as seven U.S. rate hikes this year, has cast a pall over the yuan outlook, historically an ill wind for neighbors.

Claudio Piron, co-head of Asia fixed income and foreign exchange at BofA Securities in Singapore, said that the yuan played a key role in stabilizing Asian currencies in 2021 and even outperformed the dollar.

He predicts that policy headwinds can drag it about 5% to 6.70 per dollar this year.

This yuan depreciation will have a negative impact on Asian currencies, especially the South Korean won and Taiwan dollar. The yuan, which suffered its heaviest selling in seven months, has returned to normal after dropping sharply against the dollar on January 27. The yuan is flat for the year, at 6.36 per dollar.

The South Korean won is under pressure and a long rally in the Taiwan dollar has stopped.

The reasons that supported the yuan are fading, said Ken Peng, head of investment strategy at Citi Private Bank in Asia.

Bond inflows have shrunk sharply as the positive carry disappears, he said. The trade surplus will probably retreat from record levels, leaving the yuan vulnerable to falling to 6.50 per dollar this year, he thinks.

Foreign holdings of Chinese bonds rose to a new record of almost $400 billion last month, but flows have been slowing as the gap between Chinese and US 10 year yields has almost halved since December.

A stable yuan provides a pillar of strength in the region, as it reflects a strong Chinese economy, according to analysts. Asian exporters see that as positive, reducing the immediate need for currency devaluation.

The central bank of China has pledged to keep the currency stable, but authorities stress the need to prepare for two-way volatility, and analysts expect downward pressure to increase as U.S. interest rates rise.

In previous bouts of weakness, such as a devaluation to support the economy in 2015 or its slide due to trade tensions in 2018, has typically resulted in pressure on currencies, including the Thai baht, Malaysian ringgit, Indonesian rupiah and Singapore dollar.

If the yuan becomes more volatile, it will likely result in reduced foreign flows to China and hurt overall flows to Asia, said Mitul Kotecha, TD Securities emerging markets strategist in Singapore.

He does not believe that there will be a repeat of the regional contagion seen in 2015, as China s outbound capital controls have tightened, but he noted that the Philippines and Thailand appeared most vulnerable to foreign flows drying up.

The yuan has stopped rallying rather than falling and the riskier corners of the region, such as Indonesia, have been remarkably resilient, a far cry from emerging markets walloping in 2013 when the rupiah fell 17% in five months.

Indeed, Citi s Peng sees domestic factors more relevant than any drag from the yuan, and BofA s Piron thinks a Chinese economic recovery can eventually provide support. Inflation is less pressing on Asian economies with faster growth.

If the Federal Reserve raises rates as fast as futures markets imply, pressure could mount quickly, and data shows that foreign equity investors in the region already spent last month voting with their feet. In January s outflows from Asia were the biggest in six months, leading by $4.4 billion running out of Indian stocks.