Fed To Hike Rates, As China Looks On Warily

Rate hike. No rate hike. Now rate hike.

Friday’s news that the Federal Reserve might – scratch that – will raise interest rates over the next few months should raise some caution among international markets.

The rate hike could come as early as next month or July. The reasons may be sound, namely, as Fed head Janet Yellen pointed out, that the economy is picking up steam. The rate hike to come would in fact be a continuance of policy stated several months back. The winter doldrums may be over for the U.S. They may not.

Stocks were higher after Yellen’s remarks, and that’s because investors are looking for yield. Against rising Treasuries that makes stocks, at least for now, among the most important games in town. The rally has also given rise to a stronger dollar.

And against a stronger dollar and rising U.S. stock markets, it is possible – though not immediately – to see capital flight from abroad in search of relative safety. Any port in a storm, goes the saying, with a port opening up stateside. The uptick in inflation and rates in general also means that everything from mortgages to any number of asset classes could attract interest.

The roughly 0 percent interest rates that exist in other parts of the world, amid sustained quantitative easing, also add fuel to the fire where investors want to be.

One place that could be hit by a Fed rate hike? China. It’s worth noting that, as reported in The Chicago Tribune, Chinese officials have been trying to suss out whether the hike will take place in June or July. The mere fact that this delicate dance even took place says a fair amount about the concerns that are afoot in that economic behemoth that has been slowing markedly. The exchange rate has been softening a bit, which translates into a decline in purchasing power of Chinese consumers as they travel (or purchase from the comfort of their own homes, via online transactions) abroad.

In the meantime, the Treasury just recently put Chinese yuan on a watch list geared toward monitoring unfair trade advantages. But more immediately it is China’s concern that a stronger dollar might further weaken the yuan.

The PBOC has shown willingness to step in and work quickly to stabilize its currency and stock markets (partly by acting as a backstop). As we saw last year, such measures rooted with an eye on the home base, so to speak, induced volatility around the world’s equity markets. Might the stage be set for a repeat?