If you’re trying to identify next year’s big risk from global currency markets, look no further than a sharper-than-expected fall in China’s yuan.
In the many 2016 outlooks published over the past month, most major banks have forecast a 5-7 percent fall in the value of Beijing’s tightly-controlled currency over the next 12 months.
But some say that China’s concern with the need to bolster flagging exports and competitiveness, or the desire of Chinese savers to get more money out, could easily provoke a faster fall or one of 10 percent or more.
That would in turn encourage more money to leave China and China-related investments, slashing the value of currencies in South Korea, Malaysia or Taiwan and raising broader questions over the durability of Chinese growth – now so vital to a hobbling global economy.
“The risk is this depreciation of the yuan becomes less orderly,” said Vincent Chaigneau, Head of Global Rates and Currency Strategy with Societe Generale in London.
“A fall to 6.80 over the next year I would call orderly. If that happens within three months, it would be less so.”
The yuan presently stands at about 6.47 to the dollar.
A sign of what may follow a steep fall in its value came on Aug. 11, when Beijing made a surprise one-off 3-percent devaluation. Global markets shuddered and less than two weeks later Wall Street recorded its biggest fall in four years.
Data from banking network Swift show it is now the fourth-most used currency for international payments, and the two big bank-to-bank trading platforms – Thomson Reuters and ICAP-owned EBS – both say it is now among their top five most traded currencies.
Major banks’ forecasts for the yuan would in the past have been buried deep in the margins of their annual outlooks, safe in the knowledge that few big investors were actively trading it.
Instead, a variety of yuan plays are among the top trades they have recommended to their global client base for 2016.
A refocus on its trade-weighted value against a range of currencies rather than the dollar has complicated matters, but Reuters FX polling at the start of December forecasts onshore yuan rates at 6.55 per dollar in a year’s time versus 6.4723 now.
Of the foreign exchange market’s top six banks, Barclays forecasts it to weaken to 6.90, China specialists HSBC, Deutsche Bank and JP Morgan all say 6.70, Citi 6.69 and UBS 6.80.
“The Chinese are already devaluing. Capital outflows were probably strong in December,” says JP Morgan strategist Nikolaos Panigirtzoglou. His calculations suggest $30-40 billion will flow out of China monthly over the next year.
“Assuming the Chinese try to depreciate their currency more, especially on a trade-weighted basis, it is safe to assume we will see more capital outflow. But maybe not the same intensity of August and September.”
Most bankers assume China will remain in control of the yuan and will only steadily devalue for fear of bankrupting Chinese companies that have borrowed heavily in dollars.
While Beijing is steadily opening the way for western money to flow into its stock and bond markets, this year has also shown it ready to halt flows of the trillions in domestic savings that want to head abroad.
One big question for speculative investors is how soon that dam might break – and when the People’s Bank of China (PBOC) will find things spinning outside the control it has exerted so far.
On the basis of its trade-weighted index, the yuan is around 15 percent over-valued, says Stephen Jen, director at hedge fund SLJ Macro Partners, who estimates total demand in China for foreign assets at $3 trillion compared to current foreign currency reserves of $3.44 trillion.
“It is possible that $500 billion of outflows of this type have already taken place since last summer,” he says. “Reserves could be allowed to continue to decline toward $2 trillion over the next 2-3 years, which would still be ample to guard against various contingencies.”
Other London-based hedge fund managers say a sharper devaluation will naturally mean trouble for western exporters focused on China while sending another deflationary shock into the West.
If the yuan weakens further against the dollar, making China relatively more competitive, Asia’s other big manufacturers may respond in kind, in order to maintain the advantage achieved by their own devaluations last year.
But opinion varies on where that will play out. UBS points to the Malaysian ringgit and Indonesian rupiah as likely candidates for weakening, while JP Morgan sees this happening to the Taiwanese and Singaporean dollars.
“I think a guided 10 percent (yuan) devaluation is the absolute minimum,” said Saxo Bank chief investment officer Steen Jakobsen. “That will only take it back to where it was last year against the other Asian currencies. So there may well be more.”