(Bloomberg) — The Chinese yuan is having a greater impact on its emerging-market counterparts than ever before and may play a crucial role in determining their performance in the coming year.
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The currency’s correlation with an MSCI Inc. index of its developing-nation peers rose to record in September on a weekly basis before edging back slightly amid the omicron outbreak, Bloomberg data show. While the close relationship is partly a result of China’s large weighting, it’s also been driven by the yuan’s links to the Brazilian real reaching the strongest since at least 2008, and that with India’s rupee touching a three-year high.
The yuan’s rising global influence is yet another sign of China’s deepening connections across the world economy. Investors are increasingly being drawn to its bonds as an alternative to U.S. Treasuries, while some banks are calling for the yuan to join the dollar, euro and yen as a global reserve currency. Yet with China’s potential being offset by murky policy making and regulatory crackdowns, being tied too closely to the yuan may also backfire.
“China is going to be a very important element of emerging-market stability and the growth picture,” said Magdalena Polan, principal economist at PGIM Ltd. in London. “The willingness for Chinese policy makers to stabilize growth will be very important to the outlook for Latam and Asia and South Africa, as countries there still rely quite a lot on exports from China.”
The correlation between the yuan and its peers in the MSCI Emerging-Markets Currency Index climbed to 0.81 in September on a weekly basis from as low as 0.24 at the end of 2010, according to data compiled by Bloomberg. It was at 0.72 on Thursday. A reading of 1 would mean the assets moved in lockstep. That has traders of both emerging-market and G-10 currencies looking to the yuan for clues on where other pairs are headed.
While correlations can be measured in many ways, China’s increasing presence in global trade has progressively boosted the yuan’s links with those of its emerging-market peers. In 2000, the average developing nation sent only 2.2% of its exports to China, while that proportion has now grown to 11.3%, according to data from Societe Generale SA.
The investment bank says the yuan’s relative stability has traditionally made it most closely correlated with those of its emerging-market peers with strong and credible policy makers such as Mexico, Chile and South Korea. Since the U.S.-China trade war in 2018, however, the yuan’s links with emerging markets as a whole have grown stronger, with the average correlation rising to 83% that year, according to SocGen data.
Downside Too
There’s a risk of course that those very connections may also weigh on emerging-market currencies if the yuan begins to weaken. The major risk of that happening looks to be due to potential policy divergence, with the People’s Bank of China expected to ease monetary policy in 2022, just as central banks from the U.S., U.K. and Australia start to tighten.
The yuan will face a particular challenge as the Federal Reserve beings to raise borrowing costs, a move that is anticipated to lead to a stronger dollar and outflows from emerging markets. Still, China’s currency has so far shown itself to be relatively resilient to monetary policy at home and abroad.
China’s economy has become an increasingly important influence on global growth over the past decade, and a vital one for emerging markets, according to J.P. Morgan Private Bank. The nation’s share of global GDP in nominal U.S. dollar terms rose to 17% in 2020 from 8% a decade earlier, according to Bloomberg calculations based on World Bank data.
“Since the financial crisis, we’ve had mini cycles in global emerging markets, largely coincident in China’s property and credit cycle and since the crisis that has been the key driver of the outlook in EM for the most part,” said Alexander Wolf, head of investment strategy, Asia, at J.P. Morgan Private Bank in Hong Kong.
The yuan’s relative resilience this year has also played a role in limiting fluctuations across emerging markets, in what has otherwise been a very tumultuous 12 months.
“The fact that the yuan’s not doing too much I categorize it as a volatility suppressant,” said Paul Mackel, head of global foreign-exchange research at HSBC Holdings Plc in Hong Kong. “We believe that stability can last for longer.”
(Updates with global impact in fifth paragraph.)
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