China looks for clues to US Fed’s intentions as punters eye rate rise in June
Beijing puts up brave face against possible moves by the Fed next month to pad rates, but anticipation of higher borrowing costs could spook an already fragile recovery
When senior officials from Washington and Beijing meet next month to discuss a series of thorny issues, China might also try to seek clearer clues on the US Federal Reserve’s next move, analysts said.
The prospects of a rate increase in June have risen in recent days, and talk of higher borrowing costs in the US has driven down the yuan. China’s central bank governor Zhou Xiaochuan and Fed chairwoman Janet Yellen are expected at the Beijing meeting, which will come a week ahead of the Fed’s decision on interest rates.
A rate rise – or just the anticipation of such a move – could undermine China’s fragile economic recovery, undo its yuan exchange-rate stability and revive a worrying trend of capital outflow from the world’s second-largest economy.
China was eager to know beforehand whether the Fed was on the move, and was trying to get the message across that a rate rise in July was preferable to one in June, Bloomberg reported, citing unidentified sources. The People’s Bank of China quickly denied the report.
“Well, if China asks Yellen when the Fed will raise rates, Yellen possibly will say, ‘I don’t know, either’,” Li Liuyang, a Shanghai-based chief financial market analyst at Bank of Tokyo-Mitsubishi UFJ (China), said. “But it’s possible that both sides can talk about each other’s decision-making processes and concerns.”
Hawkish comments from Fed officials in recent days have already had an effect on the yuan – pulling it down more than 1 per cent against the US dollar this month.
Communication and even coordination between the world’s two largest economies are particularly needed at a time when the global economy is plagued by weak demand, according to He Maochun, an international relations professor at Tsinghua University.
“Despite all the China-bashing talk during the US presidential election, China still sees the need to enhance policy coordination with the US,” He said.
Changes to the yuan exchange rate, under tight control of the central bank, can send ripples across the world economy, as happened in August last year, when China suddenly devalued the currency by 2 per cent, and early this year, when Beijing kept muted its monetary intentions.
“The situation is much better now as the central bank can use the currency basket to explain modest yuan depreciations against the dollar,” Ding Shuang, chief China economist at Standard Chartered in Hong Kong, said. China could handle a rate increase in June or July – the real risk was a change in market expectations, Ding said.
“If the market believes again that the Fed will raise rates once a quarter or if the yuan weakens more than 5 per cent against the dollar in a year period, then the situation will be different.”
Going into the summer, it’s uncertain if slowdown pressure on the Chinese economy will intensify, given recent comments in state media attributed to a mysterious “authoritative” figure that were critical of the credit-fuelled rebound in the first quarter.
Since the economy got off to a turbulent start this year, Chinese officials have used high-profile forums to soothe outside concerns about China’s economic and yuan exchange rate prospects. The move helped the fragile economic recovery, and an easing of capital outflows. Foreign exchange reserves increased in both March and April.
But the risks of a reverse are never far away. Capital flight remained an issue, Alan Wheatley, an associate fellow of international economics at the British think tank Chatham House, said.
“It’s unlikely there will be capital flight on the same scale as we saw last winter if the renminbi does decline,” Wheatley said.
“But it’s obviously a risk – as is the possibility that global markets might panic at the thought that China’s economic problems are out of control.”
The psychological impact from a quarter of a percentage point increase in US dollar borrowing costs would be much greater than the actual impact on China’s economy, Stephen Li Jen, a managing partner with SLJ Macro Partners, a London-based fund and research firm, said.
“It is very difficult to make the Fed pre-commit to not raising rates, in order to preserve the de facto peg [between the yuan and the dollar],” he said. “While Yellen’s behaviour and rhetoric have been consistent with there being an implicit understanding between the Fed and the PBOC, it is a promise the Fed cannot keep.”