China's currency weakening beyond 7 to the US dollar on Monday has wide-ranging implications for asset owners globally: it could prompt reviews of investment portfolios and strategies and will lead to greater scrutiny of the risks posed by dollar-yuan moves, experts say.

This latest salvo in the prevailing US-China trade war has been widely seen as evidence that Beijing is not averse to using its currency as leverage in the dispute.

And yet it could encourage mainland investors to shift capital offshore, said Seema Shah, chief strategist at US fund house Principal Global Investors. It could also result in a wave of competitive depreciation of other Asian currencies vying to compete with China’s suddenly improved competitiveness, London-based Shah said.

Seema Shah, Principal GI

And that in turn would boost dollar strength, hurting everyone who has borrowed in the world’s reserve currency. 

“The risks of a further dollar squeeze [that is, the dollar strengthening further] and more foreign exchange volatility are now quite high,” said Nick Wall, London-based co-manager of Merian Global Investors’ Strategic Absolute Return Bond Fund.

Such scenarios should be incorporated in institutional investors’ portfolio stress tests, said Janet Li, Asia head of the wealth business at investment consultancy Mercer. 

Admittedly, for most asset owners globally, RMB-denominated assets are not mainstream investments, thus limiting the impact of the yuan move, said Hong Kong-based Li. Still, a weakening renminbi will have a direct negative impact on non-Chinese investors (because of the value of their mainland assets falling), she added, but it could also boost domestic demand, thereby boosting some investments.

EQUITY SWINGS

Ultimately, institutional investors will now focus more than in past on the currency risk in evaluating the potential yield of mainland assets, Li said.

They will also be alert to the potential global volatility that yuan moves can spark. 

Janet Li, Mercer

US benchmark index the S&P 500 closed down 3% on Monday, and the yield on 10-year US Treasuries fell to 1.672%, its lowest since October 2016. The latter tends to happen when investors, fearing volatility, start buying US government bonds as a hedge. Bond yields are inversely proportional to prices. 

Stock benchmarks in Hong Kong and Shanghai closed down 0.5% and 1.6%, respectively, with Japan's Nikkei losing 0.7%.

Such volatility may lead to investors seeking higher yields to maintain current levels of risk-adjusted returns on Chinese assets, a Hong Kong-based institutional sales head at a European asset manager said on condition of anonymity. 

POTENTIAL RESOLUTION

Ultimately, though, a weaker currency would be against China’s economic interests and could prompt Beijing to “hammer out an agreement” in talks with the US in September, said Stephen Chiu, a foreign exchange and interest rate strategist at Bloomberg Intelligence.

Andy Seaman, chief investment officer at London-based Stratton Street Capital, agreed that the currency issue could help resolve the trade dispute. 

A stronger renminbi would suit Beijing, as long as it saw a gradual appreciation, because that would fit with its plan for China to be a more consumer-driven economy and for its companies to invest overseas, he told AsianInvestor early this year. It would also suit Washington, he added, because the dollar is overvalued and a weak greenback makes American exporters more competitive.

Indeed, the yuan has weakened 1.7% against the greenback since US president Donald Trump said on August 1 that the US would impose a 10% tariff on a further $300 billion worth of imports from China. If the threat does materialise come September 1, and China responds, the global economy could enter a recession within three quarters, wrote Morgan Stanley economists in a note to clients.

PREVAILING TENSIONS

And for now, there are no signs of the tensions abating. 

US Treasury Secretary Steven Mnuchin said in a statement that Washington had determined that China was manipulating its currency and would engage with the International Monetary Fund to eliminate unfair competition from Beijing.

In turn, China appears seems prepared to “pay the cost of a full-blown trade war”, said Hao Zhou, a currency analyst at Germany’s Commerzbank. “[And] there is little hope that President Trump could back down at this stage.”

Trump tweeted on August 5: “China dropped the price of their currency to an almost historic low. It’s called “currency manipulation. Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!"

Analysts point out that a stronger dollar that makes the US economy less competitive coupled with the slowdown effects of a trade war may stay the hand of the Fed that wants to wait for inflation to pick up before another rate cut. 

Joe Marsh contributed to this article.

Investors interested in the strategies of China’s asset owners can learn more at AsianInvestor's 6th Institutional Investment Forum China, to be held on September 18th in Bejing. Please click here for more details.