Rally in China’s Yuan Would Benefit Latin American Currencies Most

(Bloomberg) -- Latin-American currencies have swung to become the emerging world’s best performers in the past month from the worst. U.S.-China tensions may hold the key for further gains.

A rapid rally in China’s currency would benefit its peers in Latin America the most, according to a Bloomberg analysis of sensitivity to the yuan during periods when markets are being driven by trade news. The exchange rates of commodity exporters such as Colombia, Brazil and Chile have seen a one-for-one move with the yuan during times when China’s currency moved 2% or more over a short period.

While tensions between the world’s two largest economies have escalated over recent weeks, signs are emerging that the phase-one U.S.-China trade agreement is likely to stay intact. U.S. Trade Representative Robert Lighthizer affirmed the deal’s progress last week as China continued to buy U.S. soybeans despite earlier reports of a halt. Although President Donald Trump continues to criticize Beijing over the coronavirus pandemic and Hong Kong, he has stopped short of pulling out of the agreement.

Foreign-exchange positioning suggests investors are becoming less concerned about further weakness in emerging markets. Bets on volatility fell by the most since 2011 last week as developing-nation currencies rallied the most in four years against the dollar. The yuan, often seen as an anchor for its emerging peers, has rebounded from last month’s slide to strengthen beyond its 50-day moving average for the first time since March. Risk reversals on the currency have fallen, while implied volatility gauges remain below levels seen in March.

Sensitivity to the yuan is of course a double-edged sword for emerging-market currencies as there remains a distinct possibility U.S.-China relations will sour again as the American presidential election nears. Only last week, the Trump administration placed new limits on Chinese airlines. Analysts at Goldman Sachs Group Inc. are among those who see further weakness in the yuan amid uncertainty over U.S. policy. All Latin American currencies weakened on Tuesday amid a pause in the global risk rally.

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The Bloomberg analysis found other currencies that tend to be closely correlated with the yuan include the Australian and New Zealand dollars. Exchange rates of countries with strong bilateral trade relations with China, including the Malaysian ringgit, South Korean won, Taiwan dollar and Singapore dollar, may also see significant volatility. A 1% move in yuan has lead to an average 0.6% shift in these currencies.

NOTE: Simon Flint is an emerging-market strategist at Bloomberg News. The observations he makes are his own and not intended as investment advice.

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