Tags: fed | rates | china | economy

Fed Shouldn't Wait for All Global Woulds to Heal Before US Rate Hike

Fed Shouldn't Wait for All Global Woulds to Heal Before US Rate Hike

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Monday, 14 September 2015 07:35 AM Current | Bio | Archive

China provided us over the weekend, once again, "sluggish" economic numbers/indicators.

Chinese industrial production edged only up by 0.1 percent to a 6.1 percent year-over-year (y/y) increase while a 6.5 percent increase had been expected.

The country’s power generation rose 1.0 percent y/y while China’s thermal power generation fell 64 TWh (terawatt-hours) year-to-date (January-August), which is by the way more than total yearly power demand of Belgium. Fixed asset investment rose 10.9 percent y/y, which was its lowest level since 2000.

Unsurprisingly (at least in some way, as government intervention seemed to be absent today), all this pushed the Chinese stock markets well into the red. The Shanghai composite index ended down 2.67 percent.

Besides all that, Barclays decreased its Chinese GDP growth forecast for 2016 to 6.0 percent from 6.6 percent before, while for this year it expects GDP growth at 6.6 percent, down from 6.8 percent.

In context of all this, the Daiwa Institute of Research, which is part of the Japanese investment bank Daiwa Securities Group that is the second largest securities brokerage in Japan after Nomura Securities, published a report titled: “What will happen if China’s economic bubble bursts?” wherein we read: “… it cannot be denied that there is always the possibility that both China’s economy and the global financial markets could be thrown into turmoil. What is more frightening is the risk of a major capital stock adjustment. "

According to a DIR (Defensive Interval Ratio) simulation, if a capital stock adjustment were to occur, China’s potential growth rate would at best fall to around 4 percent, while real economic growth would hover at around zero. A more serious meltdown would see China’s potential growth rate falling to as little as 1.6 percent, with real economic growth bringing in significantly negative numbers.”

Please take care; nobody is pretending the people at the Daiwa Institute of Research got it right.

Nevertheless, I think long-term investors probably couldn’t do wrong by considering this report as “food for thought.”

Fact is money has been leaving China in record amounts since end of 2014.

These capital outflows have caused enormous pressure on the Chinese currency and have certainly been part of the rationale for devaluing the yuan on August 11.

In contrast with what politicians say, the yuan has only one way to go and that is lower against the dollar, but that’s my personal opinion.

If Barclays’ foreign exchange research team got it right, then the POBC (People’s Bank of China) should, because of the current pace of capital outflows, cut the “reserve requirement ratio” (RRR) by at least 40 basis points each month and that only to offset the negative effects on liquidity from its foreign exchange interventions.

Barclays and SocGen expect now the yuan to weaken by about 7 percent against the dollar before year-end. Societe Generale China economist Wei Yao describes this move as a “war of attrition against capital outflows.”

In fact, one could ask him/herself, what is the logic maintaining an “overvalued” currency for a shrinking economy?

When we look at the Bank for International Settlements’ (BIS) nominal effective exchange rates (EER), which is their index that describes the relative strength of a currency relative to a basket of other currencies, we see that in Q1 of 2015 China had an index value of 124.3, the U.S. 112.8, the Eurozone 95, the UK 111.7, Japan 76.8, and so on.

It’s clear, China has besides its re-balancing undertaking also the task of adjusting their currency to more realistic levels, which could cause serious upheavals (currency war!) if they do it to quickly.

About Thursday’s FOMC decision on the fed funds rate, I would only like to say the Fed cannot and should not give due consideration to each and every market sensitivity which would involve delaying Fed policy tightening into perpetuity, but that's my personal opinion.

No doubt once the normalization process has started, whenever that is, the Fed will await the extremely difficult task of guiding the markets into tougher territory.

In the meantime, the Fed holds the “known unknown.”

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HansParisis
China provided us over the weekend, once again, "sluggish" economic numbers/indicators. Chinese industrial production edged only up by 0.1 percent to a 6.1 percent year-over-year (y/y) increase while a 6.5 percent increase had been expected
fed, rates, china, economy
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2015-35-14
Monday, 14 September 2015 07:35 AM
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