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U.S.-China Trade Worries Drag Down Yuan

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12/07/2018 | 01:10am CET

By Ira Iosebashvili and Julie Wernau

The yuan is falling again as investors grapple with fresh prospects of deteriorating trade relations between the U.S. and China.

China's currency has pared much of the gains it garnered in a two-day rally sparked by signs of progress in trade talks at last weekend's summit of Group of 20 leaders in Buenos Aires. The arrest this week of a top Chinese tech executive has some investors concerned that a trade truce between the U.S. and China could be more complicated to maintain than anticipated.

The yuan is down 5.5% against the dollar this year, on track for its biggest loss against the U.S. currency since 2016. One dollar recently purchased 6.88 offshore yuan, compared with around 6.30 this summer.

More weakness in the yuan could further complicate trade talks between the U.S. and China, analysts said, as a lower yuan makes Chinese exports more competitive abroad. President Trump has complained that China and Europe are intentionally weakening their currencies to disadvantage the U.S., and the U.S. Treasury voiced concern in October about Beijing's currency practices, though it stopped short of labeling China a "currency manipulator."

One factor behind recent swings in U.S. stocks and bonds are fears that an intensifying trade conflict could weigh on global growth. Although China's central bank partly controls the yuan's fluctuations, some investors would view further weakness in the currency as an indication that trade tensions are hurting the Chinese economy.

The S&P 500 has lost 2.3% this month, while the yield on the U.S. 10-year Treasury has fallen below 3%.

A situation in which growth contracts in the U.S. while also falling in China and Europe would likely add further volatility to already turbulent global markets, said Adnan Akant, head of currencies at BNP Paribas Asset Management.

"That scenario probably has the dollar strengthening, the yuan blowing through 7...and emerging markets going back down the drain," he said.

The narrowing gap in yields offered by U.S. and Chinese assets has contributed to the yuan's fall. While the U.S. has been raising interest rates and will likely continue raising borrowing costs into next year, China has tried to support growth by pursuing a looser monetary policy. Rising yields on U.S. debt dim the allure of Chinese assets, where high yields often come with more risk.

If that trend continues, short-term yields for dollar bonds will surpass yields of a similar maturity for yuan debt in 2019 for the first time in about a decade, analysts at UBS Global Wealth Management said.

A falling yuan would also worry investors betting that other emerging market currencies will rebound next year. The MSCI Emerging Markets Currencies Index is down 3.4% this year. The world's second largest economy, China is a key consumer for many emerging-market exports, especially commodities. Some developed-market currencies, such as the Australian and New Zealand dollars, are also particularly sensitive to the yuan's fluctuations. China is an important market for Australian commodities, such as iron ore, and for New Zealand's dairy products.

"If you get a significantly weaker yuan, how can there be a big rally in emerging markets, which are so impacted by the Chinese economy?" said Kit Juckes, a strategist at Société Générale.

Worries about stoking the trade conflict with the U.S. could force China to prevent its currency from falling too rapidly, analysts said. So will concerns over capital flight from China, which a weaker currency would exacerbate.

Positive developments in trade negotiations could also slow or reverse the yuan's decline. The dollar could rise to 7.5 yuan next year if the U.S. implements more tariffs on Chinese imports, while a trade deal and reduced tariffs could push the yuan to 6.5, a report from UBS Global Wealth Management said.

Still, some are concerned that a weaker yuan could spook investors into lightening up on Chinese assets and drive markets lower, as they did during sharp selloffs in 2015.

"Any depreciation with a communication or signal to the market of further depreciation can lead to local investors front running that move, more weakness and more capital flight," said Phil Torres, global co-head of emerging markets debt at Aegon Asset Management.

Write to Ira Iosebashvili at ira.iosebashvili@wsj.com and Julie Wernau at Julie.Wernau@wsj.com

Stocks mentioned in the article
ChangeLast1st jan.
DJ INDUSTRIAL -0.66% 23938.14 Delayed Quote.-2.50%
NASDAQ 100 -0.53% 6563.8918 Delayed Quote.3.10%
NASDAQ COMP. -0.63% 6870.4281 Delayed Quote.0.11%
S&P 500 -0.66% 2583.31 Delayed Quote.-2.76%
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