CHINA’S premier Hu Jintao might have upheld his steely resistance to any pressure from the US to revalue the yuan yesterday, but there is little doubt that it is a question of when Beijing will revalue, not if. Although Chinese officials have always been very clear that any move would be gradual, an appreciation of the yuan will have an impact on the currency markets. Therefore, foreign exchange traders should be preparing themselves now for a change by identifying which other currencies are likely to be most affected by a stronger yuan.
The most obvious are the emerging Asian currencies. Deutsche Bank analysts expect the net impact of a shift in China’s FX regime to be positive, as a Chinese adjustment may catalyse fresh upward momentum in these currencies. Tellingly, when US Treasury secretary Tim Geithner announced that he would postpone the currency report – indicating a shift towards less aggressive currency negotiations between Washington and Beijing – emerging Asian currencies rallied across the board.
However, traders cannot assume that all emerging Asian currencies will respond equally. Deutsche Bank analysts Mirza Baig and Dennis Tan reckon that both the Indian rupee and the Malaysian ringgit are starting to look a little stretched at their current levels. Asian central banks are aware of the need to lift rates but are wary of moving too quickly ahead of other regional central banks in case they lose competitiveness in the export markets.
While both the Indian and Malaysian central banks have already hiked rates, their counterparts in Taiwan, Singapore and South Korea have yet to do so. These countries’ central banks heavily manage their currencies, and faced with fiscal and inflationary pressures would like to see them appreciate. Any Chinese revaluation will cause a more dramatic upward move for these currencies than for the ringgit or the rupee, which have already started to appreciate.
Bank of Tokyo-Mitsubishi UFJ said last week that the South Korean won and the Indonesian rupiah may climb about 13 per cent against the yen as central banks from Indonesia to Taiwan raise interest rates and reduce currency intervention. And against the US dollar, Nomura forecasts that the won will appreciate by 9.6 per cent, the Singapore dollar by 9.1 per cent and the Taiwanese dollar by 5.3 per cent. These are more easily tradable than the Chinese yuan, which is non-deliverable. Jens Nordvig, a managing director of foreign exchange research at Nomura, says that we will see a much more immediate impact of a Chinese revaluation in South Korea, Taiwan, Malaysia and the Philippines.
It is not just emerging Asian currencies that will be affected by a yuan appreciation. Analysis by Singapore-based Barclays Capital analysts David Forrester and Yuki Sakasai suggests that the Japanese yen will be the biggest gainer among the G10 currencies, while the Australian and New Zealand dollars will be the biggest losers. There are two main reasons for this.
Firstly, an appreciation of the yuan would be perceived by the market as a tightening in monetary conditions and spark investor concern about a slowdown in Chinese economic growth. The yen, which typically strengthens when investors’ risk appetite weakens, would do well in this scenario. In contrast, the Australian dollar and the New Zealand dollar tend to do well when risk appetite is higher – the boom in Chinese growth has underpinned both these currencies over the past six months.
Secondly, a revaluation of the Chinese yuan would also increase worries among investors that China’s voracious appetite for commodities is waning – any reduction in demand could prompt a drop in commodity prices. Therefore, currencies with a higher exposure to commodities, such as the Aussie and the Kiwi, would underperform, says Forrester. The Japanese yen would also benefit from this because it is a large commodity importer.
Given that the markets are speculating about a move by Beijing in the coming months and are already starting to price in a change, currency traders would do well to establish positions in these currencies now before any revaluation does happen and the opportunity has been missed.