How does the weakening of the US dollar affect the AH premium?

The continuous weakening of the US dollar will reshape the premium relationship between A-shares and H-shares, creating differentiated investment opportunities for investors.

According to news from the Chasing Wind Trading Desk, UBS's latest report predicts that the US dollar will continue to depreciate, which will be beneficial for global stock markets, especially emerging markets—based on the beta coefficient over the past decade, a 10% decline in the DXY dollar index could bring a 9% excess return to emerging markets.

For Chinese investors, UBS expects the renminbi to be slightly stronger against the US dollar. As part of the emerging markets, A-shares will benefit from foreign capital inflows, but due to the foreign ownership ratio being only 3.4%, the room for benefit is limited. At the same time, the AH premium has shown a high positive correlation of 0.83 with the dollar index over the past 15 years, which means that in a weakening dollar environment, H-shares may perform better than A-shares, especially in the context of global liquidity easing.

UBS predicts that in the second half of 2025, under the expectation of continued weakening of the dollar, the AH premium may remain at mid-term low levels unless there is a significant improvement in liquidity for A-shares.

Structural Reasons for Dollar Weakness: A Long-Term Trend Has Formed

UBS forecasts that the dollar will continue to weaken in 2025, setting year-end targets for the euro/dollar and dollar/yen at 1.23 and 130, respectively. In addition to the slowdown in US GDP growth and the Federal Reserve's interest rate cuts, UBS also lists four structural reasons for the continued weakening of the dollar:

Expansion of US External Debt: From 9% of GDP in 2005 to the current 88%.

"Overholding" of the Dollar: The US accounts for only 16% of global trade, but the dollar makes up 58% of global foreign exchange reserves. UBS's foreign exchange team estimates that G10 countries have about $13.4 trillion in unhedged dollar positions; a mere 5% reduction could lead to a $670 billion dollar sell-off.

Global Tariff Disruption Risks: Trade protectionism may affect the dollar's status.

Overvaluation from a Purchasing Power Parity Perspective: Fundamentally, the dollar is still overvalued.

Emerging Markets May Be the Biggest Winners, A-shares Moderately Benefiting

UBS's global equity strategy team believes that the weakening dollar is a positive factor for global stock markets, which have historically shown a negative correlation. Regionally, emerging markets may be the biggest winners. Based on data from the past decade, UBS estimates that a 10% decline in the dollar index will bring a 9% excess performance to emerging markets relative to global stock markets.

The report shows that historical data indicates that when the renminbi appreciates against the US dollar, the CSI 300 index usually rises, providing support for the A-share market in a weak dollar environment.

UBS's Chinese economists believe that China is unlikely to use renminbi depreciation as a policy tool to respond to tariff increases, nor will it actively promote a significant appreciation of the renminbi, expecting the renminbi exchange rate to be slightly stronger in the short term in 2025 According to a previous article by Jianwen, on Monday, Zou Lan, Deputy Governor of the People's Bank of China, stated that China does not seek to gain international competitive advantages through currency depreciation. The People's Bank's stance on exchange rate policy is clear and consistent, and it will continue to uphold the decisive role of the market in exchange rate formation, maintain exchange rate flexibility, strengthen expectation guidance, prevent excessive exchange rate fluctuations, and keep the RMB exchange rate basically stable at a reasonable and balanced level.

As part of the global emerging markets, the A-shares should naturally benefit from the global capital inflow brought about by the slight appreciation of the RMB. However, due to the relatively low proportion of foreign investment in A-shares, the extent to which the A-share market benefits from foreign capital inflow is relatively limited:

According to data from the People's Bank, as of the end of the first quarter of 2025, the amount of A-shares held by foreign investors was 2.97 trillion RMB, accounting for only 3.4% of the total market capitalization of A-shares.

In the MSCI China Index, the weight of A-shares is 17%.

From a profit perspective, industries and companies with a higher proportion of imports in their costs or significant exposure to dollar-denominated debt will benefit more from a weaker dollar. Industries in A-shares with high exposure to dollar-denominated debt include home appliances, transportation, non-ferrous metals, and electronics.

The Relationship Between AH Premium and the Dollar Index: Liquidity is the Key Factor

Research has found that over the past fifteen years, the AH premium has been highly correlated with the dollar index, with a correlation coefficient of 0.83. This seems counterintuitive, as the Hong Kong dollar is pegged to the US dollar, and theoretically, a strong dollar should lead to better performance of H-shares (denominated in HKD) compared to A-shares. However, historically, when the dollar strengthens, the AH premium usually rises.

UBS believes that the reason lies in the fact that although H-shares are denominated in HKD, the companies primarily operate in mainland China, and their assets are mainly denominated in RMB. Therefore, the fair value of H-shares is basically unaffected by exchange rate changes, and the relative performance of AH is unlikely to be significantly impacted by exchange rate conversions. In fact, the linkage between the AH premium and the dollar index mainly reflects the differences in onshore and offshore liquidity conditions:

A stronger dollar usually reflects tightening overseas liquidity, which may drag down H-share performance.

When the dollar weakens, global liquidity is loose, and emerging markets experience net inflows of global capital, H-shares will perform better.

AH Premium May Maintain Mid-term Low Levels in the Second Half of the Year

In the first half of 2025, as the dollar index weakened, the AH premium fell back, mainly due to the significant differences in liquidity conditions between A-shares and H-shares. From the perspective of global capital flows, a weak dollar has led to net inflows into emerging markets, and since H-shares have a larger weight in emerging markets, this trend is more favorable for H-shares Specific data shows:

In the first half of 2025, net inflows of southbound funds reached 684.2 billion RMB (mainly flowing to Chinese internet giants, innovative pharmaceuticals, and new consumption industries), a year-on-year increase of 101%, setting a historical high.

In contrast, the issuance of A-share mutual funds has been relatively weak, with the new issuance scale of actively managed mutual funds in the first half of 2025 being 92.2 billion RMB, far below the average level of 513.8 billion RMB in the first half of 2020-2022.

UBS expects that in the second half of 2025, as the US dollar may further weaken, the AH premium may remain at mid-term low levels unless there is a significant influx of additional liquidity into the A-share market.

For investors, in the context of a weakening US dollar and global liquidity easing, H-shares may offer better investment opportunities, especially in sectors benefiting from southbound fund inflows, such as internet, innovative pharmaceuticals, and new consumption industries. At the same time, industries in the A-share market with high import costs or significant US dollar debt exposure, such as home appliances, transportation, non-ferrous metals, and electronics, are also worth paying attention to.