The Cable

Concerns About Chinese Spillover Gives the Fed Caution on Raising Interest Rates

Fed minutes send a mixed message on a September rate hike as concerns about Chinese economic spillover grow.

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The next Federal Reserve meeting is four weeks away, and there appears to be no consensus so far on whether to lift interest rates from zero percent, according to minutes released Wednesday of Fed meetings held July 28-29. In turn, that has sent mixed signals to Wall Street and policymakers around the world who are watching for any ripple effects from China’s economic slowdown.

Amid increasing concerns over China’s devalued currency and sliding stock market, brokers and politicos are parsing every word of the Fed document for even a hint of when rates will go up. There are fears that if the U.S. central bank makes borrowing more expensive, it could stunt domestic economic growth.

Yet some, like Bankrate.com chief financial analyst Greg McBride, said it’s time for the Fed to raise rates and allow the market to react — for better or worse — regardless of concerns about China. “Unemployment is under 5 percent. If that doesn’t justify raising rates, I don’t know what does,” McBride told Foreign Policy.  

Persistent concern about China is prevalent throughout the notes of the Fed’s meeting. While President Barack Obama has insisted the American economy is insulated from a Chinese slowdown, Fed officials clearly aren’t as confident.

Although the Chinese stock market slump is expected to only have a limited knock-on effect for its own domestic growth “several participants noted that a material slowdown in Chinese economic activity could pose risks to the U.S. economic outlook,” the minutes said.

The July meeting occurred before China devalued its currency, and before its stock market continued its plunge. On Wednesday, Chinese equities continued their wild ride, with the Shanghai Composite up 1.2 percent after sliding as much as 5 percent over the course of the day. On Tuesday, the index was down 6 percent. This all comes as China’s year-over-year exports decreased by 8.3 percent in July, and with increasing worries Beijing won’t hit its 7 percent growth target for 2015.

“Devaluation by itself isn’t a big deal. But the extent by which it shows weakness in the Chinese economy and emerging market economies is,” Donald Kohn, who served on the Board of Governors of the Federal Reserve from 2002 to 2010, told FP in a recent interview.

Among other indicators, China is keeping Fed officials cautious. Inflation — the rate at which the cost of goods and services goes up — is still below a 2 percent target the Fed says it needs to increase the cost of borrowing. But officials think the U.S. economy is getting close to the end of free borrowing.

“Most [officials] judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point,” the Fed minutes said.

Photo Credit: Mark Wilson/Getty Images

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