A day after second-ranked Lee Chong Wei of Malaysia was sent packing, top seed Chen was beaten 21-19 21-17 as Xue atoned for his early defeat last year to advance to the quarter-finals of the sport's oldest event.
"I have to say the top seeds losing means the general standard of men's singles is very high," Chen told reporters. "I am feeling well but I will have to go home and find out what went wrong today."
Chen looked comfortable enough in the opening game but seemed unable to put away the shuttle at important moments while fast-moving Xue dominated the mid-court exchanges when it mattered.
Xue did not celebrate when the champion went wide on match point and said that was due to their friendship "being probably even closer than our parents...when we play we couldn't play at 100 percent as we know each other's game so well. I had all the luck".
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Five-times champion Lin Dan progressed by defeating Japan's Sho Sasaki.
Fifth seed Lin suffered a wobble before the gifted Chinese found his rhythm to win 20-22 21-6 21-8.
"It took me time to get into the match but I changed my tactics and stayed calm," he said after his 64-minute victory.
Lin next meets third-seeded Dane Jan O Jorgensen, the 2015 runner-up who ousted Hong Kong's Ng Ka Long Angus on Thursday.
In the women's event, second seed Saina Nehwal of India breezed past Thailand's Busanan Ongbumrungphan 21-16 21-9.
"I've been carrying the expectations for many years," said Nehwal of her huge fan base. "At the same time I know every match counts because so many people are following me."
Sixth seed Ratchanok Intanon was in fine form as she advanced to the quarter-finals for the fourth time.
Thailand's number one ousted Akane Yamaguchi of Japan 21-9 21-13 and next plays defending champion Carolina Marin of Spain.
(Editing by Tony Jimenez)
