China's Holiday Week Only Gets Worse as Stocks Slump With Yuan

(Bloomberg) -- Financial markets are closed all week in China, but across the border in Hong Kong, things are getting ugly.

The benchmark Hang Seng Index slid 1.7 percent Thursday, taking its three-day loss to 4.2 percent, the worst since February. The offshore yuan weakened beyond its support level of 6.9 per dollar, while surging Treasury yields signal pressure on Chinese government debt when trading resumes next week.

China's Holiday Week Only Gets Worse as Stocks Slump With Yuan

Chinese assets are being hit by a double whammy. Evidence of economic strength in the U.S. and a more hawkish Federal Reserve are propelling a flow of funds out of emerging markets into American assets, while rising concern the trade war will hurt China’s economy is adding to bearish sentiment.

“It’s hard to reverse Hong Kong stocks’ falling trend if economic data stay weak and the trade war threat remains,” said Linus Yip, a strategist at First Shanghai Securities Ltd. in Hong Kong.

The losses suggest China’s onshore traders will have a tough return to work on Monday, given many of the same companies are listed in both Hong Kong and Shanghai. When mainland investors began their holidays last week, the outlook seemed brighter -- the Shanghai Composite Index closed at its highest level since the start of August.

China's Holiday Week Only Gets Worse as Stocks Slump With Yuan

The yuan was down 0.15 percent at 6.900 per dollar at 4:35 p.m. in Hong Kong, in line for its lowest close since Aug. 15 after earlier falling as much as 0.40 percent. The Bloomberg Dollar Spot index rose 0.3 percent, extending its six-day gain to 1.6 percent, after Fed Chairman Jerome Powell said the central bank may eventually boost its benchmark past the neutral level.

Bank of America Merrill Lynch said Tuesday the yuan is likely to fall to 7.05 per greenback in the first quarter next year, compared with a previous forecast of 6.9, while JPMorgan Chase & Co. sees it weakening to 7.01 by the end of December as China loosens monetary policy to shore up growth.

Authorities may drain offshore yuan liquidity and push up funding costs to prevent aggressive yuan short selling, said Ken Cheung, a senior foreign exchange strategist at Mizuho Bank Ltd., adding that the currency is likely to weaken to 6.91-6.92 in the near term.

Trade Tension

The trade conflict will only escalate as the U.S. maxes out tariffs on Chinese imports, the dollar strengthens and the yuan weakens further, JPMorgan Chase & Co. strategists including Pedro Martins Junior, Rajiv Batra and Sanaya Tavaria wrote in a report, lowering their recommendation on Chinese stocks to neutral from overweight.

Tensions between Washington and Beijing flared up last week when the Trump administration slapped a 10 percent tariff on about $200 billion of Chinese goods. Xi Jinping’s government responded in kind with duties on $60 billion in U.S. products, scuppering hopes for any quick solution to the dispute.

“A full-blown trade war becomes our new base case scenario for 2019,” the JPMorgan strategists wrote in a note dated Wednesday. “There is no clear sign of mitigating confrontation between China and the U.S. in the near term.”

©2018 Bloomberg L.P.