How Long Will China Hold Back US Rate Rise?

MARKET REACTION: Volatility in emerging markets caused the Fed to push back an interest rate rise in the US. How long will Chinese troubles hinder the West?

Emma Wall 23 September, 2015 | 11:21AM
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Emma Wall: Hello and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Mike Bell, Global Market Strategist for JP Morgan, to talk about the Fed not raising rates.

Hi, Mike.

Mike Bell: Hi.

Wall: So, the Fed decided last week not to raise interest rates as many had expected throughout the summer because of volatility in China. Now, volatility in China is not going away anytime soon. We've had reports today that the new norm for GDP growth in China maybe 4% and getting to that point is certainly going to be a bumpy ride. So, at what point do we just have to say, you know what, China, you do your own thing and we'll get on with economic growth and all the things that go along with it, like raising rates in the West?

Bell: Well, frankly, I think they should have got to that point already and that they should have raised interest rates when they decided not to. We think really though they are going to go ahead and do it by the end of the year, whether it's October, December doesn't really matter. We think that the unemployment rate is going to continue coming down. The Fed are pretty negative on that and think that it's not actually going to come down as fast as we expect. Therefore, we think they need to get on with increasing interest rates because otherwise you're going to have a situation where they are slightly behind the curve and then have to increase them faster than they would otherwise.

And I guess what you think from China is that 4% number seems very pessimistic in our view. We think that probably Chinese growth is going to start with a 6% this year and next and then from there you can see a situation whereby you get a gradual slowing in the Chinese economy as a move towards a more service-based economy. But it's worth noting that retail sales in China are still going at about 10%. They've got room for a meaningful stimulus still. We expect further cuts in the reserve requirement ratio and also, property prices look to have bottomed out and you could see some further improvement there. So, it's not all bad news from China and frankly, the Fed should just get on with it and raise rates.

Wall: How much does China affect the U.S. and affect U.S. growth, because we know it does have an effect on countries like Germany, which rely on China for a number of its revenue streams. But is the U.S. just perhaps being overly cautious as you've alluded to there?

Bell: Yeah. So, the analysis we've done suggests that actually a slowdown in Chinese growth of about 1% of GDP has very minimal impact on the U.S. economy. On Europe and Japan it has a greater influence where you see about a 0.4% impact for a 1% slowdown in Chinese growth whereas in the U.S. it's far less than that. So, the U.S. is a source of demand for the Chinese economy but not really the other way round and therefore, we think that they are being overly cautious.

Wall: And where the U.S. goes, the U.K. tends to follow. We're about a year behind in the growth story from the U.S. Does this mean that we will be taking a leaf out of their book and delaying interest rate rises here because of what's going on in China?

Bell: I think certainly that the Bank of England doesn't want to go before the Fed. So, each time that the Fed pushes back its rate rise then the Bank of England is likely to wait for them partly because of the impact that it going first would have on Sterling. Now, a stronger U.S. dollar doesn't have that great an impact on the U.S. economy even though it has impacted U.S. company earnings, whereas the Pound is more influential for the U.K. economy and therefore, we think that they are likely to wait for the Fed to go. That said, we do still think that the Bank of England will raise interest rates next year. It's just that the continued weakness in emerging markets that you're seeing, which as you say, may drag on for some period of time could mean that the pace of increases next year is slightly slower than it would otherwise have been.

Wall: Good news for home buyers?

Bell: Exactly, yes. It's good news in general probably for the equity market given that rates will go up slower and for the domestic economy in both of those countries.

Wall: Mike, thank you very much.

Bell: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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