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Here’s why investors shouldn’t take their eyes off China’s yuan

(Source: marketwatch.com)

Market participants await the U.S. Treasury’s report on foreign exchange practices that could lead to China being labeled a currency manipulator for weakening the yuan. But the Chinese currency faces a number of downside risks, said Simon Derrick, currency strategist at BNY Mellon.

Read: Here’s how far the U.S. may go in criticizing China’s currency practices

In the wake of last week’s global equity rout, which was accompanied by selloffs in other assets perceived as risky, the yuan seems to have disappeared from investors’ radars, Derrick said. “However, with U.S. Treasury yields beginning to creep higher again, President Donald Trump hinting at further tariffs on Chinese goods and the CSI 300 trading at close to its lowest level since the summer of 2016, the continued risk of a fresh bout of weakness cannot be ignored.”

U.S. Treasury yields have been on the rise with the 10-year note yield

TMUBMUSD10Y, -0.03%

 hitting a seven-year high at 3.261% last week before retreating amid haven flows sparked by the global equity selloff. Meanwhile, Trump said in an interview over the past weekend that a third round of import tariffs could come and that China wouldn’t be able to fight back.

China’s CSI 300 Index

000300, -2.37%

 has fallen more than 9% in the month so far, and is down more than 22% in the year-to-date, according to FactSet.

What happens with the yuan has implications for Asian emerging market currencies such as the Taiwan dollar

USDTWD, +0.2688%

 or South Korean won

USDKRW, +0.58%

but potential ripples could reach even further, Derrick warned.

“Given the relatively fragile risk sentiment evident in global markets, this suggests keeping a close eye on Chinese markets in the coming weeks,” he added.

In onshore trading, the yuan

USDCNY, +0.1747%

 has weakened 6.1% versus the U.S. dollar

DXY, -0.02%

this year, while the drop was slightly more contained at 5.9% in the offshore market

USDCNH, +0.2092%

But wouldn’t the People’s Bank of China step in to use reserves and fight the yuan’s weakness? Not necessarily, Derrick said. After the August 2015 devaluation scare that rippled through global financial markets, authorities may have discovered that their “approach is not without risk” and that it highlights “how ineffective intervention can prove to be for anything other than smoothing purposes.”

That means attempting to smooth out a downturn, not prevent one.

Since late August, when the PBOC reintroduced the so-called countercyclical factor to its currency management measures, the yuan has steadily ground lower.

“In short, the best that can be said is that the authorities have stabilized the situation for the moment,” Derrick said.

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More Info: marketwatch.com

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