By Jamie McGeever
ORLANDO, Fla. (Reuters) – Japanese and Chinese monetary policies are diverging, meaning other Asian currencies may now be at a crossroads, too.
But are currencies like the South Korean won, Indian rupee and Indonesian rupiah affected by a stronger yen, supported by expectations of tighter monetary policy from the Bank of Japan, or by a weaker yuan due to the People’s Bank of China’s need to ease monetary policy to stimulate the struggling economy?
Until recently, the yen and yuan were correlated with each other, with both under heavy selling pressure as the Fed’s continued expectations of “higher interest rates for longer” pushed up the value of the US dollar. But that relationship and US interest rate expectations have changed.
Between late April and mid-July, the simple 30-day moving average correlation between the yen and the yuan strengthened steadily to a positive high in ten months. But the correlation has since reversed.
This is largely because the People’s Bank of China surprised markets last week by cutting its key interest rates. The yuan, which is tightly controlled by the central bank, was pegged to its weakest level against the dollar this week. Meanwhile, Chinese bond yields have hit all-time lows, and downward pressure on the exchange rate is firmly on the rise.
Meanwhile, the yen has jumped about 8% from a 38-year low against the dollar. The Bank of Japan followed up its historic interest rate hike in March — its first in 17 years — with a bigger-than-expected increase on Wednesday and signaled its commitment to ending its decades-long use of ultra-loose monetary policy.
Of course, Tokyo’s $100 billion in yen-buying intervention in the past few months has been enough to put a floor under the currency, and the Bank of Japan’s approach to raising interest rates is anything but optimistic. So the yen is not a sure bet to strengthen strongly from here on out.
But the policy difference with China is clear, which is clouding other Asian currencies.
From the slight devaluation of the Chinese currency in 2015 to the start of the Fed’s latest rate hike cycle, all Asian currencies have been more sensitive to the dollar/yuan than the dollar/yen, especially the won, rupee, Malaysian ringgit and Taiwan dollar. Even the Indian rupee, the Asian currency least affected by the yuan, was still three times more sensitive to Chinese currency movements than the Japanese yen.
But once the Fed started tightening monetary policy in 2022, Asian currencies began to be mostly affected by the unusual rise in the value of the dollar/yen. According to analysts at Goldman Sachs, longer-term correlations show that the yen’s influence on Asian currencies increased significantly when US interest rates started to rise.
But that link has faded since the Fed stopped raising interest rates a year ago.
“As such, the US dollar is broadly more important to the Asian foreign exchange market than its emerging market counterparts,” they wrote in a recent report.
So if the yuan remains weak, Asian currencies may remain weak even as the Fed’s easing cycle weighs on the dollar. That may not be bad news—given China’s economic struggles and a potential slowdown in U.S. growth, Asian capitals may welcome weaker exchange rates more than they fear inflationary consequences.
Beijing is unlikely to be too upset if the yuan and yen diverge in value.
Since the start of the pandemic in March 2020, the Japanese currency has depreciated by about 30% against the yuan. In other words, on a simplified exchange rate basis, Japanese goods have become 30% cheaper over that period compared to similar Chinese goods on the international market.
Meanwhile, China is also facing the specter of an escalating trade conflict with the United States. The trade war between the two countries during Donald Trump’s presidency was followed by protectionist policies under President Joe Biden’s administration, and now the dark cloud of much heavier US tariffs looms after the November election.
All of this has had the expected effect: US imports from China as a share of total imports fell by 8% over 2017-23, according to Oxford Economics. However, the share of US imports from Europe, Mexico, Vietnam, Taiwan, and South Korea has risen. At the same time, all of these countries—especially Vietnam—have seen their imports from China rise as a share of total imports over the same period.
Beijing will want to ensure that any deterioration in bilateral trade between the United States and China continues to be offset elsewhere, and the weakness of the yuan, relative to its main regional rival the yen, may help.
(The views expressed here are those of the author, a Reuters columnist.)
(Written by Jamie McGeever, Editing by Thomas Janowski)