19 April 2019
The market response to Fed chief Janet Yellen's rate hike has been generally positive. Photo: AFP
The market response to Fed chief Janet Yellen's rate hike has been generally positive. Photo: AFP

The Yellen hike: market verdict is coming

Whether Janet Yellen’s rate hike is a right move is determined by how the market will respond to it.

The US economy has almost got over the recession as judged by the two policy objectives of the US Federal Reserve – fostering maximum employment and price stability.

November’s unemployment rate has dropped to 5 percent while the consumer price index has also booked a modest rise of 2 percent. All these seem to support Yellen’s decision.

The US stock market is still on a bull run since 2011 and so is the home market. Washington may be more concerned about its economy getting overheated than another downturn.

US policymakers are not obliged to consider the economic well-being of other nations unless their decisions will exacerbate the woes overseas and ultimately return to hurt the US economy.

The economic fundamentals elsewhere are far from being upbeat: Europe is still stuck in a prolonged stagflation while Asian economies may be weighted down by China’s fatigued growth.

That was why Yellen was seen humming and hawing over the past months.

We all know that economists seldom agree with each other. Even though many had been anticipating rate hikes, the Federal Reserve’s own experts didn’t see eye to eye on the matter. Some eminent scholars, like Lawrence Summers, were even up in arms about the move.

Now that the first step is taken, the market will soon have its verdict.

The most instant gauge can be the overnight London interbank offered rate of the US dollar.

Another one is the Fed’s own sale and repurchase transactions. Central banks use this policy tool to absorb liquidity from the market and should there be a spike in the amount when investors are lured by the Fed’s higher interest, then it can be an indication that the market is not following the rate hike.

Surely what really matters is how the real economy responds: if private investment or durable goods sales will be choked.

One intermediary data between the financial market and the real economy is the mortgage interest rate, which has been on a steady rise amid a strengthening employment rate. Whether the rise can be sustained after the historic Fed move remains to be seen.

The renminbi may soften further when its offshore unit has already hit the 6.5 level against the US dollar. The rate increase has complicated the old woes, like lukewarm growth, tepid export as well as fleeing domestic and overseas capital.

Last week Beijing launched a new exchange rate index for its currency in which a basket of 13 foreign currencies was adopted.

The timing has fueled suspicion that Beijing wants to shift attention away from the redback’s performance against the US dollar after the Fed starts to normalize policy. The fear is that the RMB may be dragged down even more.

People’s Bank of China Governor Zhou Xiaochuan (周小川) promised just a few months ago that the currency wouldn’t depreciate further, citing the trade surplus and stable economic fundamentals.

I hope investors were not misled by Zhou’s remarks, otherwise they may have already incurred losses.

This article appeared in the Hong Kong Economic Journal on Dec. 17.

Translation by Frank Chen

[Chinese version 中文版]

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Former full-time member of the Hong Kong Government’s Central Policy Unit, former editor-in-chief of the Hong Kong Economic Journal

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