All eyes on Fed chief’s comments as China’s growth outlook plays big part in direction of US interest rates
- Washington in focus as Fed assesses health of Chinese economy
- Beijing in focus as Chinese policymakers assess effect of US rates rise
Chinese economic policymakers will be watching the Federal Reserve on Wednesday, when the US central bank is widely expected to increase its main interest rate for a fourth time this year.
An increase is not expected to prompt an immediate response from Beijing, but officials, like other observers, will be listening closely to the tone of Fed chairman Jerome Powell’s remarks for clues as to the path of US interest rates next year, experts said.
With the global economy slowing, many analysts think the Fed will raise rates less frequently in 2019 than anticipated earlier this year.
The Fed’s judgment on when and by how much to raise interest rates next year will depend in no small part on the decisions that Chinese policymakers take to stabilise their economy.
Coincidentally, the Fed’s meeting runs over the same two days as China’s Central Economic Work Conference (CEWC), during which economic planners will thrash out policy for next year.
And it is clear that the Fed is paying as close attention to Chinese policy as the Chinese are giving to the Fed.
Fed policymakers have made it clear that they set their interest rates based solely on domestic US economic conditions, with foreign influences having an effect on policy only when they influence the US economy.
The slowdown in China’s economy is having just such an impact.
It is rare for any country to be mentioned in the minutes of a Fed policy meeting, but the record of the last meeting in November referred to China nine times. Only one of those references, however, was in relation to the trade war. For the most part, China was discussed in the context of its slowing economy and how that could have a negative effect on the US.
So, for this meeting, analysts will pay close attention to any mention of China in the Fed’s statement and comments from Powell for clues about the level of Fed concern and how it might affect rate decisions.
The Fed will stay out of the trade war crossfire, with any mention of China to be purely apolitical, analysts agreed.
“Any Fed reference to China has got to be seen in terms of any economic spillover effects. That is the context,” said Mike Gallagher, managing director at research firm Continuum Economics. “China is not just about the trade war, it’s also about domestic slowing. But the Fed will be cognisant that the Chinese authorities have re-stimulated since the summer, it will not therefore be too worried about a hard landing in China before the summer.”
The nearly unanimous view among economists is that the Fed will raise rates by a quarter of a percentage point at Wednesday’s meeting, taking the Fed’s main interest rate to 2.5 per cent. “This hike is fully discounted by markets,” said Steve Donze, senior macro strategist at Pictet Asset Management.
The bigger question is how much further the Fed will increase interest rates next year. Most analysts now predict that the US central bank has appetite for at least two more rise in 2019, while some expect three.
But that depends in large part on the outlook for the world economy. That, in turn, depends on the outlook for the Chinese economy, which has been the main engine of global growth since the financial crisis 10 years ago.
The Fed’s comments on Wednesday will be very important in determining how concerned it is with the Chinese and global growth outlooks.
“We all agree there will be a hike. More important is what will come from the [Powell] press conference or statement following the meeting,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Bank. “The tone of the press conference will be important. They [China] will look at it very closely. The Fed is not involved in the trade negotiation, but their policy always has implications for Chinese monetary policy.”
Like their Western counterparts, Beijing officials will be looking for indicators from Powell’s comments as to the outlook for US monetary policy next year, which may have some bearing on the Chinese government’s own monetary and fiscal policy choices.
“The speech straight after the meeting will be very closely scrutinised, more than ever, given the high expectation of a rise,” said Jack Siu, senior investment strategy, Asia-Pacific, at Credit Suisse.
Analysts will also be closely watching the Federal Reserve’s “dot plot”, released after the meeting, which shows the projections of each of the Federal Open Markets Committee’s 12 members, and which is generally viewed as the best gauge of the outlook for US interest rates.
“We’re looking for three hikes for the Fed [next year]. The dot plot will back that up,” said Mike Gallagher at Continuum Economics. “The Fed communications will not be too hawkish. But there’s enough momentum in the US economy to clearly see the Fed hiking in March, June and most probably September as well.”
Chinese policymakers are not expected to react immediately to Wednesday’s rate rise, but they will have options for policy changes in support of the economic stimulus plan the government will debate at the CEWC this week.
The direct effect of the Fed decision will be a further narrowing of the gap between the US and Chinese interest rates, which theoretically would put additional depreciation pressure on the Chinese yuan.
But it is unlikely the People’s Bank of China (PBOC) will raise domestic interest rates to restore the differential, given that higher interest rates are exactly the opposite of what the struggling Chinese economy needs right now. Indeed, the central bank has refrained from raising its interest rates after each of the past two Federal Reserve rate rises.
And some analysts interviewed by the South China Morning Post said that the Fed rise would offer China leeway for some currency depreciation next year, which would be a means of boosting its stuttering export sector.
“A well-performing US economy helps to maintain global growth, which benefits China,” said Vincent Reinhart, chief economist at Standish, part of BNY Mellon Investment Management, and former economist at the Federal Reserve. “Higher US interest rates make it easier for Chinese officials to permit modest depreciation of the yuan, which supports export growth and counters any adverse effects of the trade dispute on activity.”
The PBOC may also consider cuts in its official interest rates to boost growth.
Reductions in the one-year lending rate and interbank lending rate have been reportedly earmarked as a way of lowering borrowing costs in China, which would be a further stimulus for the economy.
“While some may think that this [Fed hike] equates to downward pressure on the [yuan] and limits the monetary easing room for China, we disagree. Further rate cuts and lower interest rates remain likely in China given slowing economic growth,” said Pin Ru Tan, Asia-Pacific rates strategist at HSBC Research.
China’s economic indicators continued to perform poorly last week, with retail sales growth for November plummeting to a 15-year low and industrial production growth falling to its weakest point since 2008.
The economy is facing internal and external headwinds, which have led most analysts to expect new stimulus measures early in 2019. The level of stimulus may be influenced by US monetary policy, analysts said.
“There will be tax cuts, at the top of the [Chinese] policy agenda,” said Christy Tan, head of markets for Asia at National Bank of Australia. “I don’t think we’ll see the kind of trillion RMB stimulus we’ve seen in the past, but we’re looking at other policy levers to support the economy, SMEs [small and medium-sized enterprises], and to ensure that credit expansion is still valid. They’ve been struggling with [maintaining their] deleveraging [campaign to reduce excess debt and risky lending] while at the same time not stifling overall economic momentum.”
Many institutions have been moved to downgrade their growth forecast for China’s economy in 2019.
“The forecast slowdown in growth derives from two main sources – China’s domestic deleveraging and external trade,” said Lillian Li, a senior analyst at Moody’s Investors Services, which has reduced its China economic growth outlook to 6 per cent in 2019.
“While the former is under the control of the authorities, we expect that the commitment to deleveraging remains intact in the long term despite recent developments pointing to a pause in the pace of deleveraging in the short term,” she said.
The expectation of a rate rise comes despite Powell facing very public pressure from Trump to keep official interest rates low. In an interview with Reuters last week, the president said Powell had been “far too aggressive” in raising rates and suggested that another increase could imperil the US position in its trade war with China.
“You have to understand, we’re fighting some trade battles and we’re winning. But I need accommodation, too,” he said.
Trump took to Twitter on Monday to hammer home his opposition to the expected rise, writing that “It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike.”