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Asian currencies hammered, with worse to come

Frank van den Bergh | E+ | Getty Images

Chinese's surprise move to devalue the yuan, a looming Federal Reserve interest rate hike and weakening economic momentum in the region have created a perfect storm for Asian currencies, say analysts, who warn investors to brace for an extended period of volatility ahead.

Regional currencies suffered a second day of heavy losses on Wednesday as the People's Bank of China (PBoC) set its daily midpoint reference rate even weaker than Tuesday's devaluation, rekindling concerns around the health of the world's second largest economy.

The Indonesian rupiah led the declines, falling 1.7 percent against the U.S. dollar to its lowest level since July 1998, while the Malaysian ringgit slid 1.4 percent to its weakest since September 1998. The Singapore dollar, Taiwan dollar and Philippine peso, meanwhile, all touched five-year lows.

The Chinese central bank set the midpoint rate at 6.3306 per dollar prior to market open, sharply weaker than the previous fix of 6.2298 and Tuesday's close of 6.3231. That marks the weakest guidance rate for the currency since October 2012, according to Reuters.

The yuan – which is allowed to trade as much as 2 percent on either side of the official midpoint – subsequently fell 1.6 percent to trade at 6.4266 per dollar.

"Today's fixing has prompted another bout of volatility in Asian FX markets. It is a bit of a surprise that the PBoC has actually fixed the midpoint so close to the level that it closed at yesterday. There were some questions over whether China would really carry through with the market-driven pricing," said Mitul Kotecha, head of Asia Pacific FX Strategy, at Barclays. "This suggests a serious intent by the central bank," he added.

The magnitude of the selloff in Asian currencies is reflective of a couple of factors, say analysts: a weaker yuan hurts the export competitiveness of China's neighbors and erodes China's purchasing power, potentially reducing imports.

"Most countries like their currencies weaker if the dominant player in the region is weakening its currency," said Emma Lawson, senior currency strategist at National Australia Bank, adding that central banks are less willing to defend their currencies in this sort of environment.

"If there's a perception that there will be an allowance of currency depreciation, this tends to heighten capital outflows, and these sorts of selloffs tend to get a life of their own," she said.

Read MoreCurrency war? How China devaluation may impact Fed

Several central bank officials and finance ministers in the region issued statements regarding the sharp losses in their currencies. The Indonesian central bank said the rupiah depreciation did not reflect economic fundamentals but global sentiment, while the South Korean Finance Minister said the government was closely monitoring the foreign exchange markets.

The PBOC's surprise policy change is just the latest headache for Asian currencies, which have been struggling in the face of a strengthening greenback.

With the Fed expected to raise interest rates for the first time in nearly a decade in September and weakening economic momentum in the region, it certainly means more downside risk for Asian currencies, say analysts.

"I see more pressure and more volatility – particular with the Fed looming," said Lawson.