‘Measured” fall in China’s yuan now justified with US Fed raising rates now and into 2016

PUBLISHED : Sunday, 27 December, 2015, 12:02pm
UPDATED : Sunday, 27 December, 2015, 12:01pm

With a new Star Wars movie in cinemas, some might characterise the US Federal Reserve’s decision to raise interest rates for the first time since 2006 as ‘The Force Awakens’.

But whatever the pace of future US hikes, the Fed’s move should provide ‘A New Hope’ for those seeing a stronger dollar against many currencies in Asia, especially if China’s own economic circumstances help justify further measured depreciation of the yuan.

As regards the Fed, there will be a reconfiguration of the voting membership of the Federal Reserve Open Market Committee (FOMC) in 2016 that suggests the influence of rate hawks may be more pronounced.

However, judging from the tone of Fed Chief Janet Yellen’s own comments, a gradual approach to raising US interest rates remains the US central banks’ watchword.

“It’s a myth that expansions die of old age,” said Yellen.

The Fed Chief was likely echoing a quote from the late German economist Rudi Dornbusch that “no postwar recovery has died in bed of old age — the Federal Reserve has murdered every one of them.”

Yellen is taking no chances on that score and emphasised future hikes will be measured so as to avoid precipitating a recession.

That said, the Fed’s own Summary of Economic Projections indicates the median expectation, of the 17 members of the FOMC, is currently for US rates to rise to between 1.25 and 1.5 per cent by the end of 2016.

The Fed’s direction of travel is laid out, even if the pace of the journey is still a matter of debate.

Yet just one day after the Fed raised rates, Taiwan’s central bank opted to cut their benchmark discount rate by 12.5 basis points to 1.625 per cent, a second cut in three months.

With a presidential election in Taiwan in January, some might infer a political motive behind the rate cut but that would arguably be unfair to Governor Perng Fai-nan who has been at the helm of the central bank in Taipei since 1998.

The Taiwan central bank’s announcement noted “growth in China, as well as other emerging market economies” has “decelerated considerably” and that “downside risks to the world economy remain.”

“A moderate recovery expected for the global economy next year will not be able to drive trade growth sufficiently,” concluded the central bank noting that Taiwan’s exports had already “continued to weaken recently.”

With that evaluation in mind a gentle easing of Taiwan’s monetary policy, to hopefully encourage domestic consumption, could make sense even though the Fed has just hiked rates.

In truth, Taiwan knows it cannot just focus straight on the trajectory of US monetary policy but must also look across the Strait towards what is happening in China’s economy.

And while the People’s Bank of China might be opposed to a sharp depreciation in the value of the yuan, the reality of tighter US monetary policy does help justify a measured fall in the value of China’s currency against the dollar.

It would also be a natural by-product of China’s own economic policies, which, in 2016, will probably be aimed at boosting domestic aggregate demand through continuing application of accommodative policies.

Seen in the context of a further possible weakening of the yuan, Taiwan’s move makes further sense as a slight fall in the value of the Taiwan dollar versus the greenback might itself be a natural consequence of the divergent monetary paths being adopted by Taipei and Washington.

In South Korea, the Bank of Korea held rates steady at 1.5 per cent but then moved to set a 3-year inflation target of 2 per cent, with the central bank stating it would do “its utmost to make inflation stay near the target, and also to lift the economy from low inflation.”

Whether that means a rate cut in Seoul becomes more likely will be a matter for considerable debate. But creating conditions in which the won could edge lower also makes good sense if developments elsewhere lend themselves to weaker currencies among Korea’s neighbours and competitors.

Of course Hong Kong, given its own currency peg to the greenback, would lose some competitive edge if other currencies in the region start to weaken anew against the US dollar, but that would hardly be news.

Elsewhere, the ‘Force’ may be strong for weaker Asian currencies as the region’s economies navigate a path between tighter US monetary policy and more accommodative conditions in China.