In recent months, the Chinese yuan and the euro have faced mounting pressures, with their declines creating significant ripple effects across emerging-market currencies in Asia and Europe.
As the yuan and euro play pivotal roles as “currency anchors” for smaller, trade-dependent economies, their downturn has amplified vulnerabilities, further complicating the global economic outlook.
Currency anchors like the yuan and euro act as stabilizing or destabilizing forces for neighboring economies, depending on prevailing market conditions.
Their movements often determine the trajectory of smaller, export-reliant currencies. Recent studies of correlations reveal that this anchor effect has only strengthened, making emerging markets more susceptible to the fortunes of these two currencies.
The correlation between the yuan and the Bloomberg Asia Dollar Index—a measure of emerging Asian currencies—reached a five-year high of 0.95 in November.
Similarly, the relationship between the euro and a Bloomberg index tracking central and eastern European currencies climbed to 0.6, a sharp increase from 0.2 in late September. A correlation of 1 would indicate perfect lockstep movement.
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The yuan’s decline can be attributed to multiple factors, including market disappointment over China’s lackluster stimulus measures and a surging U.S. dollar. Additionally, fears of higher U.S. tariffs on Chinese goods have further dampened sentiment.
Meanwhile, the euro has struggled under the weight of increased bets on European Central Bank (ECB) interest rate cuts, driven by weakening economic conditions in the Eurozone. This dual pressure has exacerbated challenges for countries with strong trade linkages to China and Europe.
The impact of these currency movements is far-reaching. Brendan McKenna, an emerging-markets economist at Wells Fargo Securities, highlights how China’s economic and currency challenges can spill over into the rest of Asia. “When China comes under pressure, whether from a currency or economic perspective, contagion effects are almost inevitable for its neighbors,” he explains.
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Similarly, the euro’s struggles are mirrored in the performance of eastern European currencies. Anders Faergemann, co-head of emerging markets global fixed income at Pinebridge Investments, notes that currencies like the Hungarian forint often act as proxies for regional sentiment. “If the euro weakens further, the Czech koruna and other CEE currencies are likely to bear the brunt,” he warns.
Strong trade dependencies amplify the interconnectedness between these anchor currencies and their smaller counterparts. For central and eastern European nations like Hungary, Poland, and the Czech Republic, exports to the Eurozone account for over 50% of their total shipments.
Similarly, in Asia, China is a crucial trading partner, absorbing at least 20% of exports from countries such as South Korea, Indonesia, and Malaysia.
A depreciating yuan or euro exerts downward pressure on these currencies, a phenomenon that can sometimes be welcomed by export-dependent economies seeking to maintain competitiveness. However, excessive weakness risks destabilizing financial systems and fueling inflation.
Adding to the challenges, the threat of higher U.S. tariffs looms large. Since his election victory, President-elect Donald Trump has floated the idea of imposing a 25% tariff on imports from Mexico and Canada, along with a 10% duty on Chinese goods. These policies, if enacted, would likely further weigh on the yuan, euro, and their emerging-market peers.
“Speculation around Trump’s policies has already painted a target on CEE currencies,” Faergemann observes. The Hungarian forint, often seen as a bellwether for the region, has already weakened, and the Czech koruna could face even greater pressures if tariffs materialize.
As the yuan approaches the critical threshold of 7.50 per dollar, the Reserve Bank of India may consider allowing the rupee to weaken to maintain stability in the yuan-rupee cross rate, according to Wim Vandenhoeck, a senior portfolio manager at Invesco. This scenario underscores the intricate balancing act that central banks in emerging markets must perform to navigate external shocks.
The global economic landscape remains precarious, with the interplay of weakening anchor currencies, trade uncertainties, and geopolitical risks creating a complex environment for policymakers.