China's yuan has fared better than many other major currencies this year. It's shed 6.5% against the US dollar, holding its ground as the greenback has gone on a breakneck rally. The euro, the British pound and South Korea's won have all dropped more than 10%, while Japan's yen has plunged nearly 16%.
But US House Speaker Nancy Pelosi's controversial trip to Taiwan is reminding investors of the risks that come with holding renminbi.
What's happening: Pelosi's high-profile visit to Taipei, where she asserted on Wednesday that Washington would "not abandon" the democratically governed island, has fed fears of a further deterioration in the relationship between China and the United States, the world's two biggest economies.
Beijing quickly said it would launch live-ammunition military drills around Taiwan and suspended imports of natural sand and some fruit and fish. China is Taiwan's largest trading partner.
The flare-up in tensions has fed concerns among investors that the situation could escalate from here, either intentionally or inadvertently. China's ruling Communist Party claims Taiwan as its own, despite never having controlled it. China's offshore yuan has pulled back slightly this week.
"It's something investors have known about for a while as a potential flash point," Manik Narain, head of cross-asset strategy for emerging markets at UBS, told me. "It's been very hard to trade it. We don't know if it will be a flash point tomorrow or in five years' time."
One big unknown: If China were to launch a military confrontation, would Western countries impose harsh economic sanctions, as they did when Russia invaded Ukraine? What would that mean for foreign investors if they did?
"They can see what happened to Russian markets," Narain said. "Investors don't want to be making that same mistake twice."
Excising China from the global economy would be a near-impossible task given its integration with supply chains, the importance of the market to large Western corporations and the country's manufacturing might. But the threat of such a significant geopolitical breakdown looms.
It's not the only factor weighing on China's currency. Emerging markets are struggling to attract investments as US interest rates rise, which makes parking money in higher-risk locations look less attractive.
There are also questions about China's economic growth. Factory activity contracted in July, according to data released last weekend. A global recession would hurt the country's robust export machine. And domestic demand remains shaky, as the country deals with the aftershocks of recent Covid-19 lockdowns in major cities and a vulnerable real estate sector.
"At a time when exports will likely run out of steam soon on weaker global demand, China's domestic demand recovery is unlikely to materialize soon, in our view, given continued Covid curbs and recent shocks to the property market," Bank of America economists Helen Qiao and Miao Ouyang said in a research note this week.
Plus, as the economy stutters, the People's Bank of China is on track to ease policy while most other central banks are tightening it. That could add to downward pressure on the yuan.
"The pace at which the US raises interest rates could be crucial," Narain said, noting the potential for a sharp "divergence."
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