Emerging markets at mercy of falling Yuan as currency war looms. Here's why

China’s yuan is back at the top of emerging-market investor worries as the deepening standoff between the U.S. and China over trade threatens to evolve into a currency battle.

As the dollar strengthens amid the trade tensions, the slide in the yuan is spurring concern that China might be embracing purposeful devaluation as a policy tool. That stoked the ire of U.S. President Donald Trump, who accused the country and the European Union of manipulating their currencies. The offshore yuan’s one-week implied volatility jumped to a five-month high.

“The yuan’s definitely weighing on risk, although much more so on Asia,” said Edwin Gutierrez, the London-based head of emerging-market sovereign debt at Aberdeen Standard Investments. “But we are confident that the Chinese will not let things get disorderly. Having recently won the battle against capital outflows, they’re not about to stoke those again by letting the currency depreciate significantly.”

The People’s Bank of China last week fixed the currency past 6.7 per dollar for the first time in almost a year and on Friday weakened the reference rate the most in two years. A further drop in the yuan to 7 against the dollar may trigger another round of panic selling in emerging markets, Gutierrez said. The currency regained some ground on Friday after a big Chinese bank sold dollars, traders said. On Monday, the PBOC strengthened the yuan’s fixing by 0.12 percent.

Asian currencies, including the South Korean won and Indonesian rupiah, have borne the brunt of the sell-off in emerging markets this month, with the yuan the worst performer after Turkey’s lira.

The Argentine and Mexican peso as well as Brazil’s real have been the top-performing developing-nation currencies this month. Aberdeen Standard has been overweight Latin American currencies “for quite a while,” Gutierrez said.

Erdogan Era

With the majority of economists expecting a rate hike of at least one percentage point by Turkey’s central bank on Tuesday, traders will be glued to the results of policy makers’ first meeting since the re-election of President Recep Tayyip Erdogan. Inflation soared to 15.4 percent in June, about three times the central bank’s target

“In the case of a continuation of loose fiscal and quasi-fiscal policies, the CBT is likely to be forced to hike further in the rest of the year,” Morgan Stanley analysts wrote in an emailed note

Other Rate Decisions

After the Bank of Russia adopted a hawkish tone at its meeting in June, economists see rate setters keeping their benchmark on hold at 7.25 percent on Friday. From a planned increase in value-added tax next year to ruble weakness and steady gains in wages, inflation pressures are building, according to BCS Financial Group

Morgan Stanley economists including Pasquale Diana expect a “somewhat cautious tone” when Hungarian policy makers meet on Tuesday, despite rates having eased since their last decision. Dovish monetary policy makes currencies such as Hungary’s forint and Poland’s zloty vulnerable to capital outflows, according to Warsaw-based mBank analysts led by Ernest Pytlarczyk. The regulator may leave the base rate at a record-low 0.9 percent, according to all economists in a Bloomberg survey

Nigeria announces its rate decision on Tuesday, with markets mostly expecting it to hold at a record-high of 14 percent. While inflation is slowing, a pickup in outflows in the past few months amid the emerging-market sell-off may make the central bank wary of easing monetary policy

Ghana, Chile, Georgia and Colombia will also decide on rates

Former Cricket Hero for Prime Minister?

Pakistan voters go to the polls Wednesday with the incumbent Pakistan Muslim League-Nawaz and former cricket star Imran Khan’s Tehreek-e-Insaf, or Movement for Justice, almost neck-and-neck. The nation’s fast-deteriorating economy means that whoever wins will likely have to go to the International Monetary Fund for another bailout. The benchmark KSE100 Index of stocks this month fell to the lowest level since 2017

Brazil’s Presidential Race

Developments in Brazil’s presidential race could influence local markets after the Democratic Workers Party, or PDT, endorsed leftist Ciro Gomes. Traders will also eye confirmation that Brazil’s “centrao” coalition has agreed to back former Sao Paulo Governor Geraldo Alckmin, as reported by local media. Support for Alckmin, a market-friendly candidate who has been lagging behind in recent polls, could give him as much as 40 percent of total television ad time. The real has trailed major peers this year

Brazil economic data for release include the current account, trade and loans. Weaker-than-expected data is another reason for the underperformance of Brazilian assets. The biggest exchange-traded fund, the iShares MSCI Brazil ETF, earlier this month suffered it sharpest daily outflow since 2015

Other Economic Data

South Korea will report its preliminary figure for gross domestic product on Thursday. The government lowered its forecast for Asia’s fourth-largest economy on July 18 to 2.9 percent from an earlier 3 percent, citing rising global trade tensions. That follows the move of Bank of Korea, which revised down its 2018 estimate to 2.9 percent while leaving the inflation outlook unchanged

The Philippines reported on Monday a budget deficit of 54.3 billion pesos ($1 billion) for June. That took the shortfall for the first six months of the year to 193 billion pesos, compared with a deficit of 154.5 billion pesos in the year-earlier period. President Rodrigo Duterte needs 9 trillion pesos to fund a program to build roads and railways through 2022. The government forecasts its budget deficit will swell to 3.2 percent of gross domestic product in 2019, which would be the highest in nine years, from a projected 3 percent this year

Taiwan will report industrial production and unemployment data on Monday

Mexico-watchers also have their pick of economic figures, with data due on inflation, retail sales, trade and unemployment. The Mexican peso has surprised many analysts with a stronger-than-expected performance after the presidential election, leading Morgan Stanley to revise its forecast for the year