U.S. Voters May Hold Key to Emerging-Market Currencies’ Fate

(Bloomberg) -- For clues on likely swings in emerging-market currencies, keep a close eye on U.S. public attitudes toward China.

The logic works like this. The more inclined American voters are to engage in China-bashing, the more likely it is that President Donald Trump will slap fresh tariffs on Chinese goods. That in turn may provoke the People’s Bank of China into weakening the yuan at its daily fixings, triggering another bout of currency volatility.

Increased turmoil in foreign-exchange markets is the last thing developing markets need right now as bellwethers such as the Turkish lira and Brazilian real trade at or near all-time lows. Currency swings haven’t eased as much for the emerging markets as they have for the leading economies since they climbed to the highest since 2011 in March. And for David Dollar, a senior fellow at Brookings Institution, the prospect of another spike in volatility is very real.

“There’s a greater than 50% chance that we will see additional tariffs against China before the Presidential election,” Dollar, an expert on U.S.-China economic relations, said in an interview from Washington.

Until now, the Chinese authorities haven’t been provoked by Trump’s saber-rattling. One key signal for the currency came with the central bank’s daily fixing on May 6, which was slightly stronger than expected, suggesting China’s willingness to limit volatility. The offshore yuan peaked at 7.1561 on May 4 during this month’s holiday, while the onshore fixing rate peaked at 7.0931 on May 7.

If Dollar is right, there would be a significant sell-off in the yuan to offset the cost of the tariffs. And there are real reasons for concern. A recent Pew Research Center poll found that 66% of Americans hold unfavorable views on China, and with the U.S. economy struggling from the pandemic, President Trump may look to exploit that to win votes. Washington could point to Beijing’s failure to get close to the run-rate for purchases called for under the trade agreement, however unreasonable that could seem under the circumstances of Covid-19.

In this respect, China probably reasons that allowing the yuan to depreciate would simply stoke tensions with the U.S., especially ahead of its highest-profile annual political meeting scheduled for May 22. It could also create domestic capital-outflow risk.

From the U.S. side too, there’s the risk of inflicting a further shock on the economy. President Trump has shown before that a sizable adverse U.S. stock market reaction can push him to alter course. Furthermore, foreign affairs and trade are rarely important election issues. The economy, health care, immigration, all tend to feature more prominently.

The Chinese yuan gained 0.1% to 7.0999 per dollar as of 12:45 p.m. in New York on Tuesday, rebounding from its weakest level in a week. Most emerging-market currencies also strengthened as the dollar retreated against its major global peers, with the Turkish lira leading the advance.

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

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