It would seem that the Fed’s interest rate hike decision is more intertwined with China’s economic situation than at first meets the eye. According to some analysts, the main reason Fed Chair Janet Yellen put off September’s rate hike was the growing concern about China’s market volatility.
China’s rate cut introduced this week should help by leading to an increase in borrowing costs and could encourage the Fed to finally implement a hike after leaving the rate at zero for the last seven years--since 2008.
Most economists agree… that it is still too early for the Fed to act…
Asian stocks have been moving up following China’s interest rate cut and its change in lenders’ reserve requirements last Friday, setting the stage for the Fed to move in at its next policy meeting on October 27-28 and increase the benchmark rate to at least 0.25 percent.
Most economists agree, however, that it is still too early for the Fed to act and cite a possible continued global slowdown as its main concern. China’s latest policy moves are encouraging but may not offer enough reason for a Fed change. Still, other analysts believe that the probability of the Fed increasing the rate by its December policy meeting is about 36 percent.
China’s Lower Interest Rates
One of China’s most tangible achievements to date was taken on October 23rd when it freed up interest rates on bank deposits. Following its mini-devaluation in August, the yuan has returned to relative stability against the U.S. dollar. And even though the economy may not expand by precisely 7 percent this year, planners are still hopeful the growth rate can come close to this number.
Economists and trade partners have long pushed for China to break out from its dovish stance and make changes to its financial system so as to encourage progress. It has implemented several moves to drive growth including floating the yuan, loosening the state’s grip on large corporations, reducing its mound of foreign exchange reserves and putting less reliance on debt-fuelled investment. In addition, the government had pledged in 2013 to allow market forces to play a more decisive role in the economy.
International investors have been somewhat reluctant to jump on to the Chinese bandwagon and seem to have lost confidence that the world’s second largest economy is able to manage a multifaceted transition without suffering a major slowdown.
They point to the 3 percent decline in the value of the yuan as having ignited a global market selloff that lasted almost six weeks and the diminishing foreign exchange reserves are viewed as a portent of capital flight rather than healthy rebalancing.
Ben Bernanke, former chairman of the Federal Reserve believes that Yellen will be facing a difficult decision at the next FOMC meeting and will have to weigh whether there enough domestic momentum to keep the U.S. moving forward despite being dragged down by outside forces. A decision taken by the end of the two-day policy meeting scheduled to begin Tuesday may not surprise many people but will certainly have wide repercussions throughout the world.