(Bloomberg) -- Chinese stocks traded on the mainland are lagging their Hong Kong peers by the most since 2011, an underperformance that’s likely to endure as a weak yuan saps the former’s outlook. 

The CSI 300 Index of mainland shares has risen less than 3% this quarter, trailing the more than 15% jump in the Hang Seng China Enterprises Index. Lombard Odier and Union Bancaire Privee are among those expecting stocks in Hong Kong to continue drawing capital as the local currency’s peg to the dollar shields investors from the knock-in impact of higher-for-longer US rates. 

The peg has allowed the Hong Kong dollar to be the only major currency in Asia to have held its own against the greenback this year. The onshore yuan, which has weakened nearly 2% during the period, faces dim prospects as the People’s Bank of China is expected to keep monetary policy loose to support the economy. There’s even speculation that China will need to take the highly controversial move of devaluing its currency to aid exports. 

“Devaluation fear could motivate domestic investors to favor H-shares that are cheaper, denominated in Hong Kong dollar, and better positioned to benefit from the eventual cyclical boost to earnings,” said John Woods, chief investment officer for Asia at Lombard Odier.  

“A-H premium compressed steadily in 2016 in the aftermath of China’s devaluation episode,” he added, referring to the valuation premium commanded by mainland stocks over their Hong Kong listings. 

Read: Hong Kong Stocks Are Looking Hot Again as Chinese Money Pours In

The rally in Hong Kong equities, spurred by earnings optimism and cheap valuations, has received support from an influx of money from mainland investors. Their monthly purchases in 2024 have nearly doubled last year’s average, with BNP Paribas SA attributing the flows to investors diversifying out of a weakening yuan. 

Analysts anticipate China’s managed currency to face more depreciation pressure over the next few months as the Fed’s rate cuts are delayed, while weak domestic demand and an escalation of US-China trade tensions may justify the need for monetary easing. 

UBP expects the onshore yuan to weaken to 7.35 against the dollar by the end of September. On Thursday, the PBOC weakened its daily reference rate for the local currency to a level unseen since January as a jump in capital outflows and a resilient greenback pressured the central bank into loosening its grip. The yuan was little changed at 7.244 against the dollar. 

“We are seeing more flows into offshore equities, given more attractive valuations and expectations of high for longer” US rates, said Carlos Casanova, senior Asia economist at UBP. “The FX argument is weighing on onshore equities compared to offshore equities.”

For all the dollar tailwind, performance in the Hong Kong market, where many stocks are Chinese firms, also hinges on the recovery of world’s No. 2 economy. This means a dramatic weakness in the yuan triggered by China’s economic fragility will inevitably weigh on the city’s stocks. 

Yet with Hong Kong stocks on a solid uptrend, a resilient local currency may well be just another reason for investors to ride the momentum. 

“Higher US rates can lead to capital outflows from emerging markets, including China, as investors seek higher yields,” said Steve Lawrence, chief investment officer for Balfour Capital Group. “The stability offered by the dollar peg can make Hong Kong equities more attractive in the face of yuan volatility.”

(Updates with PBOC’s Thursday fixing, latest market moves)

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