ALL EYES ON WHETHER YELLEN WILL RAISE RATES
The good news is investors can pretty much put away concerns over a couple of things that have been dogging markets lately.
Greece and its creditors seem to be finally approaching yet another deal in advance of an important Aug. 20 deadline, when the government has to pay back 168- billion euros.
China’s surprise yuan devaluation has proven to have a pretty high floor, alleviating concerns that the world’s second- largest economy was going to bash everybody else in a currency war.
The move didn’t bode well for the Chinese economic outlook and commodities demand, but what else is new? Almost everybody knows that oil and base metal prices are going to remain in the tank for a long while.
Investors can turn their attention to just about the only thing that matters to markets anymore: what a particular central banker is going to decide next month.
This is not about Stephen Poloz. Yes, it’s good sport to try to predict the unpredictable and handicap the Bank of Canada’s next interest rate move. But the fact is, it probably doesn’t matter very much. Commodities prices, which have been the key drivers of Canada’s apparent technical recession in the first half, are being set in global markets, and there’s damned little that lower interest rates can do to spur more activity until prices recover.
Yes, the Canadian dollar is sinking against the greenback, but so is the currency of every other exporting country in the world.
Meanwhile, real rates of borrowing — the kind that real companies do from real banks — have declined less than the BoC’s overnight rate. And for a simple reason: there are big risks to Canada’s economic performance — the biggest being sluggish global demand for commodities.
All eyes will be on U. S. Federal Reserve chairwoman Janet Yellen to see whether she raises rates next month.
Until early August, the market was pricing in about a 60 per cent chance that the Fed would introduce a hike in September. We might have got a better sense of the odds this Wednesday, when the Federal Open Market Committee releases the minutes of its late July meeting. But that was before China devalued.
That move was important in that it sent a signal that Beijing was prepared to let the already strong U. S. dollar get even stronger. And that’s a challenge for Yellen. Over the past year, the greenback has been on a tear, and not just against the plunging Canadian dollar. The one- year gain on the Fed’s trade- weighted U. S. dollar index, which measures the U. S. dollar against a basket of currencies, is 15 per cent.
The currency pinch makes U. S. exporters less competitive, and has hit the bottom line of global U. S.- based corporations.
If Yellen raises rates, China could well loosen the yuan’s unofficial peg to the greenback once again. That would cause the U. S. dollar to rise even more — the same problem Yellen has now, only in extremis.
No wonder investors, in the wake of China’s devaluation, are now pricing in only a 50 per cent chance of a September increase. It could go either way. Among Fed watchers, the dovish outlook is that China gave Yellen an “out” from the expected September hike, because the U. S. dollar’s rise pretty much accomplished what increasing interest rates would do anyway. They also point to low inflation and poor wage growth.
The hawkish outlook points to reasonably strong GDP, and notes that the U. S. economy is more than 85- per- cent domestic. An interest- rate increase will hardly derail the U. S. recovery. Inflation is low, but interest rate increases should anticipate, not follow, rising inflation.
The dovish/ hawkish outlook is that Yellen is likely to raise rates in September, but maintain concerns over the economic outlook, leaving the Fed room to respond as the data evolve — and attempt to talk down the greenback while doing so. Whichever way the Fed decides, it will likely mean a continuing strong, and perhaps even stronger, U. S. dollar. Investors might want to consider ways to take advantage.
Mark Sept. 17 in your calendar, when the Fed’s next meeting concludes. That’s when we’ll know what’s on Yellen’s mind.