The recent devaluation of the Chinese Yuan is a reason for worry because it’s a huge event, said Joachim Fels, global economic advisor at PIMCO. Two major economies, the US and China were willing to let their currencies appreciate, which allowed the rest of the world to export their deflation. Since China just decided to jump ship, Beijing’s own deflationary pressure will now start to weigh on the rest of the world, which is a reason for worry, he noted.
Asked how far the People’s Bank of China will let the Yuan fly, Joe said till now the PBOC has allowed the currency to depreciate 4.5 percent, but the buck doesn’t stop there. The PBOC is likely to allow about 10 percent depreciation for the Yuan, he observed.
Asked if 10 percent depreciation is realistic, despite the PBOC publicly dismissing such steep cut as overblown, Joe answered in affirmative. Markets are pushing the Chinese currency lower although the PBOC, for obvious reasons, doesn’t want to be seen to be encouraging that move. They are trying to stem against it and making efforts to make it smoother. However, China would require a weaker currency eventually, because its exports and the overall economy have been sagging, which explain the latest currency slide, he argued.
Asked if it takes a September rate hike off the table in the US, Joe said he had been in the September camp for a long time, because the domestic economy has been doing well for some time now.
The latest data showed reasonably solid US retail sales in July and the labor market has made further progress. However, there could be at least a question mark over a September move because inflation is yet to show up and the Fed is unlikely to make a move unless it is reasonably confident that inflation will go back to two percent anytime soon.
Additionally, if the Yuan keeps depreciating, and the dollar keeps appreciating, the Fed might be forced to push back that first rate hike. However, the key is the domestic data and July’s labor market report is yet to come. While markets expect a reasonably solid jobs report, there’s still a question mark over a September rate hike, he noted.
Fed official Lockhart said the Fed could move and then wait for some time before moving again. Asked what the likely gap between successive rate hikes could be, Joe said it would reasonable to expect the FOMC to raise interest rates at every alternate meeting. But since the Fed claims rate lift offs would be data dependent, the hikes are likely to be very gradual.
Once the Fed starts, they would pause at least for one or two meetings to make the next move. Overall, when the rate hike comes, the Fed is likely to go out of its way to make it clear that once they hike, the next step will be gradual. That’s much more important for markets than the timing of the hike, he concluded.
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