MNI ANALYSIS: Yuan RRR Cut Could Trigger Asian FX Reversal

By Stuart Allsopp

     SINGAPORE (MNI) - Asian FX markets are starting to weaken and face greater

downside risk following the move by the People's Bank of China to cut the

reserve requirement ratio (RRR) earlier this week.

     China's April 18 RRR cut seems to mark a shift in monetary policy away from

its previous tightening bias, opening the door to further easing. Chinese bond

yields collapsed on the news, with the 1-year bond yield currently at 2.96% and

the spread versus U.S. 1-year paper falling to 78 bps, the lowest level since

2009.

     The contrasting interest rate picture puts the Chinese yuan increasingly at

risk, particularly as core inflation pressures continue to build and many Asian

and Emerging Market currencies have already begun to show weakness.

ASIAN FX-EX CHINA WEAKENING

     While the Asian dollar index remains close to its recent highs, this is

largely due to yuan strength. If we strip out the CNY from the ADXY, the picture

is much less bullish, with the index down 1.5% from its February high. If we

further strip out the HKD, which itself is facing intense downside pressure, the

performance on Asian FX has been even worse.

YUAN WEAKNESS WOULD TRIGGER REGIONAL SELLOFF

     Given the degree to which Asian central banks focus on maintaining currency

competitiveness with the CNY when controlling their currencies, it seems as

though yuan strength is a major factor preventing further weakness in Asian FX

outside of China.

     This means that any slight weakness in the Chinese yuan could trigger

significant currency weakness across the region. As we argued in a previous

article "Asian FX Risks Bearish Reversal" (See Main Wire 04/16), the recent

build-up in reserves across the region is not necessarily supportive of Asian

currencies, while the ongoing rise in oil prices should put upward pressure on

imports, reducing currency account surpluses, and leaving Asian FX susceptible

to portfolio outflows.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$A$$$,M$H$$$,M$Q$$$,MN$FX$]