Six things you need to know about the US Federal Reserve’s interest rate discussions
With the United States Federal Reserve policymakers meeting on Tuesday and Wednesday – but tipped to hold off on raising interest rates – we take a look at the six things you should know about the discussions.
1. How likely is it that the Fed will raise interest rates this summer?
The chance is small, but not impossible. The minutes of the Fed’s rate-setting meeting in April indicated that most officials thought a rise would be “appropriate” at the June meeting if economic and labour market indicators in the second quarter continued to be upbeat.
In late May, US central bank chief Janet Yellen said that a “cautious and gradual” rate rise might come in “months”.
More hawkish statements by Fed policymakers came as data showed stronger-than-expected first-quarter economic growth in the US, while concerns over a global economic downturn eased.
However, poor US employment figures in May now suggest that interest-rate normalisation will likely be postponed to until the autumn.
Other key factors deterring them from pushing through summer rate rises include a British referendum on June 23 to decide whether the country should leave the European Union, and uncertainties over the well-being of the Chinese economy.
Fed officials signalled that they had left the window open for lifting short-term interest rates as early as this week’s meeting on Tuesday to Wednesday, although it would be more usual for them to take the decision in September. The other summer Fed rate meeting will be held on July 26-27.
A majority of market watchers agree that any rate rise would be about 25 basis points, and the total rate increases this year will probably reach 50 basis points. It should be noted that Yellen has stressed that the scale of the next rate rise would be gentle.
3. What difference does it make if the increase is made in June or July?
Global markets have long been pricing in a US rate rise in the “not-too-distant” future. However, policy makers in China and other emerging economies around the world are expected to breathe a sigh of relief if the rise comes in autumn, instead of the summer.
4. What’s the likely impact on mainland China and how will China react?
It will pose an additional complication for Beijing in its push to shore up its economy.
Currency and capital flight: China’s exchange rate has already been weakening as a result of expectations about another rate rise. A greenback rally means individuals and companies might drain more money from the Chinese economy, prompting the People’s Bank of China (PBOC) – the nation’s central bank – to use more cash from its foreign currency reserves to defend the yuan from softening further.
To stem the outflows, PBOC’s can also impose more stringent capital controls, such as placing additional restrictions on forex purchases.
While observers raised doubts about the central bank’s ability to staunch another round of money flight, judging from the current size of its foreign-exchange stockpiles, those with a more sanguine view argued that the PBOC’s shift away from a quasi-dollar peg would help to soften the blow.
Stock and commodities markets:When the Fed moves, Asian markets move, too. So a rate rise spells market volatilities in China. Investors tend to dump China shares over fears of aggressive US interest rate rises, as currency fluctuations and exacerbated capital outflows are downside risks to a country’s growth.
New woes could be added to commodities market if US rates climb, because that will eliminate the buying power of consumers of raw materials, which are mostly priced in the US dollars. In addition, investors are inclined to opt for higher-yielding alternatives, such as US dollar bonds and even bank savings, instead of precious metals such as gold.
However, do not be too pessimistic: much of the Fed rate-rise expectation have been priced into the Chinese markets since the release of the hawkish Fed minutes in April.
Companies: There are more losers than winners. Higher US interest rates will increase the debt-servicing burden on Chinese businesses issuing US-dollar denominated bonds. This may spell doom for some state-owned enterprises and even force Beijing to bail them out. Mainland airline companies that have the bulk of US dollar debt, are among the most vulnerable, but export-driven firms, such as consumer companies, will benefit as their products can become cheaper overseas.
It is believed that a dovish Fed is in China’s interest. But the “authoritative source” quoted by the Communist Party mouthpiece has made it clear that Beijing will tolerate a prolonged economic slowdown, which meant that a rate rise might not shift its chief economic policy focus on structural
reforms.
5. What does it mean to the Hong Kong economy?
It will paint a gloomier picture for Hong Kong. As the city’s currency maintains a US-dollar peg and its interest rates have to shadow that of America, a US rate rise will lead to a situation where a large number of its tourists, including those from the mainland, will find themselves spending their money in a more expensive Hong Kong. A battered tourism sector will take a further toll on Hong Kong’s already struggling retail sector.
The property market, which has already declined by more than 11 per cent since its peak last September, is going to be one of the biggest losers owing to rising mortgage rates. In fact, any aggressive US rate rise should be bad news for the city’s homeowners and borrowers, who will find it harder to pay back their creditors as interest rates increase.
Moreover, with Hong Kong’s economy closely tied to the mainland, the city’s capital markets are subject to spillover effects from across the border, and higher US rates may lead to “some capital outflows”, as warned by the city’s de facto central bank chief, Norman Chan Tak-lam, chief executive of the Hong Kong Monetary Authority.
6. How did China react when Fed officials said in March that they expected two rate increases in 2016?
The Fed’s reduction to the number of its projected rate rises this year– from four to two – bodes well for China as it suggested limited room for the US dollar to appreciate further. The yuan reached a four-month high and China stocks rallied to their highest level in two months over two days following the news.
