Overview
- The Chinese renminbi has lost almost 10 per cent against the US dollar in the last 18 months as the two countries’ growth and interest rates diverged.
- But that doesn’t tell the full story. Against the yen, for example, the renminbi has gained in value.
- Past renminbi depreciation supported Chinese equities and exports. Judicious hedging of foreign exchange risk can add to returns on Chinese bonds.
On paper, it has been a rough year for the Chinese renminbi. In a year and a half the currency has lost almost a tenth of its value against the dollar. Rising US interest rates have come at a time when China’s are headed in the opposite direction, and the search for refuge from increased global risks has pushed capital towards the dollar.
“US economic growth has been exceptionally resilient… given its uneven recovery, (China) has been on an easing path,” Peiqian Liu, our Singapore-based Asia economist, tells our host, Marty Dropkin, Head of Equities, Asia Pacific. “Rising global volatility and geopolitical tensions have (also) led investors to seek safe havens.”
But the effects of a softer currency are not necessarily negative. Economic growth could get a lift, while the stock market could see a welcome recovery. Here are three things to watch, and some ideas for investors seeking to benefit:
The economy: Less sensitive
Intuitively, a softer currency should benefit exports. But trading patterns have shifted and a weaker renminbi may move the dial less for the world’s largest exporter than it did in the past.
Intermediate goods, which involve importing raw materials before adding value and selling them overseas, now play a big part in China’s export model. A weaker renminbi means pricier imports, making the eventual exported products a worse deal for China, but also adding up to a more balanced overall impact of foreign exchange moves on the economy. “(In the long run) Chinese trade will gradually become less sensitive to currency fluctuations,” explains Liu.
Near term, conventional exports sold in dollars should continue to benefit. But the dollar view doesn’t provide the full picture. Take a trip across the Sea of Japan: the yen has lost 15 per cent against the dollar so far this year. Chinese companies competing against Japan would feel the effects of a stronger currency, not a weaker one.
Equities: Ready for a reset
For what might happen to Chinese equities in the near term, however, Casey McLean, a Sydney-based portfolio manager who invests in Chinese and Australian equities, argues we should look at past models. He points to China’s one-off currency devaluation in 2015: "The Chinese equity market initially bottomed out, but then doubled in value,” he says. “Exports get a kick… export incomes go up. That translates into the rest of the sector. And there's more optimism and buoyancy throughout the whole economy.”
Exporters of automobiles and industrial automation equipment, which get most of their competition from Japan, would be most likely to benefit, Casey argues. On the flip side, companies which are heavily leveraged and holding large amounts of offshore debt are likely to hit the buffers. “Fortunately, in the listed equity market, they're relatively few and far between,” he says.
Fixed income: Hedge your bets
One of the most important questions for global investors in China is whether they should hedge their foreign exchange risk - a move that would protect their assets but could potentially limit their investment return.
“That really depends on the investment goal,” says Belinda Liao, fixed income portfolio manager in Hong Kong. “If my aim, especially as a fixed income investor, is to accumulate a very stable stream of income, I might hedge our currency exposure and also benefit from that forward rate pick-up.”
Belinda is referring to the additional return investors get by hedging in the forward market and locking in a period where their capital benefits from dollar interest rates rather than the lower alternatives applicable to the renminbi. Analysis by Fidelity International’s fixed income team also shows that a US dollar-based investor could increase long-term returns with a simple strategy that marks hard choices of when to hedge and when not. Find out more about how it works by reading this article, co-authored by Belinda.
