Here we are in the last trading day of August, and the outlook on whether or not the Federal Reserve, or any major central bank for that matter, will begin to normalize their benchmark interest rates in the near future is even more cloudy than it was 6 months ago.
It seems the consensus opinion among analysts and market participants alike has swung 180 degrees from “the Fed must raise rates ASAP” to expectations for still more monetary easing. As predictions about another round of money-printing from the European Central Bank and People’s Bank of China gain currency, it decreases the likelihood that the Fed or the Bank of England will move in the opposite direction and tighten monetary policy.
To date, the Fed and the BoE have been the two leading candidates for the distinction as the first central bank to embark on the path toward normalizing its rates.
Following China’s Downward Trajectory
Just as the pundits began praising the rebound of the U.S. economy during July, the Chinese markets began their rapid nosedive. This not only caused some overleveraged investors on the mainland and (less so) overseas to lose their shirts, but undoubtedly muddied the outlook for the Federal Reserve’s plans for raising the federal funds rate, which many had expected would come in September.
Though some have pointed out that the Chinese equities market represents only a marginal portion of the global market for stocks, with the majority of trading still centered on the New York Stock Exchange, it’s undeniable that movements in China (whether up or down) are having an ever-greater influence on financial markets in the West.
One emerging economy that was believed to benefit in a relative sense from the downturn in China was its South Asian regional rival, India. If China were to lose any of its market share in the Asian theater, so the logic went, then India would be the power in the region that is most likely to absorb that portion of the economic pie.
Yet, disappointing quarterly data seems to have put the brakes on these plans for India. After quarter-over-quarter GDP growth for the country fell well short of projections (7% vs. 7.5% expected), the Reserve Bank of India is again supposedly considering cutting rates in order to accommodate its tempered projections. Earlier in the year, the central bank had targeted annual growth rates in the neighborhood of 8% to 8.5%.
China has similarly overshot its growth expectations. Most economic experts now believe that the targets stated above for the Asian stalwarts were too ambitious. Nevertheless, most developed countries would die for the kind of expansion (“only” 7%) that the developing economies in India and China are still on pace to achieve.
Search for Explanations
Strong suspicions that the Chinese government has been intervening in order to prop up its equities and currency markets were exacerbated by internal investigations in the People’s Republic that place the blame for the correction in Chinese stocks on nefarious traders. Although dangerous trading practices are nothing new to today’s financial markets, the accusation appears to be a political witch-hunt that absolves the state from “failing” to support the economy.
As far as where the Federal Reserve’s plans are headed, not everyone has had their reasoning for raising rates shaken, even as inflation tracks far below Fed targets. For instance, the influential Fed Vice Chair Stanley Fischer remains at least tepidly in favor of a rate hike. A consensus of traders seem to believe (based on futures trading) that the chances of a September rate hike from the Fed are about 38%, with the odds of an October liftoff seen as a coin-flip.