Beware what you wish for: calls for China to loosen grip on the yuan may rock emerging and developed markets alike, strategists say

China watchers calling for Beijing to loosen its grip on the besieged yuan need to be mindful of the risk that it unleashes a chain reaction rocking emerging- and developed-market currencies alike, according to some strategists.

Most under threat are the currencies of Asian neighbours such as South Korea and Thailand, where China is the number one trading partner. But a suddenly weaker yuan may have a much wider impact, turbocharging renewed strength in the dollar, the traditional wrecking ball for developing nations’ foreign-exchange markets.

China’s managed currency is seen as an anchor for its regional peers, meaning small moves can have an outsize impact. Last month, a weaker-than–before daily reference rate triggered a slide that pulled down Asian currencies, spilled over to developed names as diverse as the Swedish krona and Canadian dollar, and bolstered havens like the yen and Swiss franc.

“We’ve gone through a period of exceptional, policy-driven stability for the yuan,” said Themistoklis Fiotakis, head of currency strategy at Barclays in London. That is unlikely to last as the “fundamentals point to the fact that the yuan should be weaker, the dollar should be stronger and volatility should be stronger as well.”

Danger signals are appearing that the yuan may be set to resume its slide after four months of relative stability. Aside from the impact of that surprise daily reference rate, pressure looks to be growing with the yuan ominously close to the edge of its fixed trading range against the dollar, a level around which authorities have pushed back with aggressive measures in the past.

The People’s Bank of China has plenty of tools available to it to support the yuan, from direct intervention to creating a dramatic liquidity squeeze in the offshore market, and has shown little intention it wants anything more than currency stability.