International

Closer Yen, Yuan Correlation Is Danger Sign for Asian Currencies

(Bloomberg)

(Bloomberg) -- Asia’s two most important currencies are moving together like never before, increasing the risk of a broad decline among their regional peers amid the relentless strength of the dollar.

The 120-day correlation between the dollar-yuan and dollar-yen currency pairs climbed to 0.54 this week, a record high in data compiled by Bloomberg starting in 2007. A reading of 1 would mean the two move in lockstep.  

The yuan is frequently described as a “currency anchor” for the rest of Asia given that other nations compete with China in global export markets. The yen is similarly influential due to Japan’s heft as the world’s third-largest economy. 

“It certainly beggars belief to suggest Asia FX are unfettered by yen and yuan weakness,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore. “The tight supply-chain and investment linkages as well as inter-dependencies mean that Asia FX will be materially impacted by yen and yuan bears.”

Weakness in either the yen or yuan often flows across to the other. China’s currency suffered its biggest one-day decline in two months on March 22, three days after the Bank of Japan disappointed markets by failing to flag future interest-rate hikes when it ended its negative rate policy.

Further yuan weakness may compel central banks across Asia to allow their own currencies to depreciate faster to maintain export competitiveness.

There’s an increasing chance the Reserve Bank of India will relax its “cap on USD/INR as India sees China as a competitor in manufacturing exports and a stronger INR versus CNY could hurt India,” Morgan Stanley strategists Min Dai and Gek Teng Khoo wrote in a research note last week. 

The increasing correlation of the yen and yuan is also a concern for global currencies as a simultaneous decline in the pair is seen adding to the broad dollar gains.

“Stability in the yen and yuan is critical to Asian FX because the weakening momentum of these two currencies will likely accentuate the broad dollar strength and will impact Asian FX as well,” said Peiqian Liu, an Asia economist at Fidelity International in Singapore.

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