By Ray Birch
WASHINGTON—Economic problems in China could not only affect further rate hikes from the Federal Reserve, they might shrink credit union net interest margins.
Those are two issues raised by economists whose biggest concern lies with China’s developing economic woes becoming a “contagion,” spreading to other countries outside the U.S., markedly affecting U.S. exports and hurting the economy stateside.
RBS this week estimated that as much as $170 billion Chinese capital flowed out of the country, with much of that going straight into the dollar.
But economists interviewed by CUToday.info believe the recent disruption in the U.S. stock market is temporary—unless China’s problems spread outside its borders—and that the market’s latest reaction to China won’t have a big impact on Fed rate decisions.
“U.S. exports to China represent just 7% of total U.S. exports—or 1% of U.S. GDP—so a continuing slowdown in China is unlikely to have a major direct effect on the U.S.,” said Mike Schenk, CUNA VP of economics and statistics. “The bigger concern, however, is that a continued substantial slowing in China will lead to a ‘contagion’ in many other countries, resulting in substantial declines in U.S. exports to those other countries as well. In the end we think that a continuing slowdown in China would slow U.S. growth, but wouldn’t be enough to put the U.S. in recession.”
Ripple Effect
The problem is like dropping a stone into a pond—there are ripple effects, said Michael Moebs, economist and CEO at Moebs $ervices in Lake Bluff, Ill. “Could China’s problems act like ripples to Pacific neighbors like Japan, India and Europe? Over the next three to six months, if the rippling effects of currency and imports and exports continues, then the Fed would have to probably back off any rate hikes. Overall, I believe there will be two rate hikes by the Fed in 2016.”
Mike Schenk, CUNA
Schenk noted that despite concerns about China’s slowing economy and the value of its currency, market experts haven’t significantly changed their view of the Fed’s timing and pace of rate increases.
“For example, on January 4th, the futures market trading reflected a 78% probability of a rate change at the Fed’s June meeting,” said Schenk. “That declined in the wake of last week’s equity market decline, reflected in a 67% probability for a June move. But the decline was not substantial. The data reflects that, given current information, the Fed’s next move would likely be in July, rather than June. Further, current pricing in the futures market reflects an expectation of the Federal funds rate ending the year at 0.73%, down only marginally from the 0.86% implied level earlier in January.”
Under a scenario with more unanticipated weakness in China, the Federal Reserve would almost certainly respond by further slowing its planned
Michael Moebs, Moebs $ervices
Federal funds rate increases, said Schenk.
Stock Market
Overall, economists feel the U.S. stock market will play less of a role in slowing Fed rate hikes than potential problems with exports. NAFCU Chief Economist Curt Long beleives that some of the latest market response to China’s problems is an overreaction.
“As much as anything, the market volatility appears to be more of a reaction to the ways in which the government in China has intervened in the markets as opposed to the actual data coming out of China,” said Long.
In fact, following Monday’s rough-and-tumble day in the Chinese stock markets, swings in the markets in Europe and the U.S. were muted, suggesting the markets are beginning to shrug off the issues in China, at least for now.
“Nevertheless, there comes a point when perception becomes reality, and certainly for the U.S. stock market, the present weakness and volatility are very real and have real implications for Fed policy,” said Long. “The present environment is in some ways similar to last August and September, when the underlying economic fundamentals were probably strong enough for the Fed to initiate liftoff, but it was prevented from doing so due to volatility in the Chinese currency market and global equity markets.”
Fed Rate Hikes
By December, however, things had settled down to the point where the Fed could go through with the first rate hike, said Long.
Curt Long, NAFCU
“So as we look ahead to the potential for a rate hike in March, while conditions are perhaps not conducive at the moment, it is too early to say that the Fed will not raise rates in the first quarter,” Long explained.
NCUA Chief Economist Ralph Monaco posited that the strength of the improving U.S. economy could affect CU net interest margins.
“As the world slows, financial market uncertainty rises. People looking for a good, relatively safe place to put their capital are coming to the U.S.,” he pointed out. “That increases the demand for dollars—the exchange rate rises—and the demand for safer financial instruments like Treasury securities. Therefore, the price of Treasury bonds rises and yields fall.”
Net Interest Margins At Risk
Monaco advised credit unions to shock their balance sheets and income statements against a wide variety of interest rate scenarios.
“A particularly troublesome one for credit unions would be if short-term rates would continue to rise with an improving economy, while long-term rates were held down by a variety of outside forces, like strong foreign demand for U.S. Treasuries. That would likely mean a narrowing of the net interest margin,” he explained.
Ralph Monaco, NCUA
Stepping back, Monaco stated that while many forces are in play that could impact the economy, U.S. overall unemployment remains very low and job growth has been solid.
“Under the assumption that the economy will continue to perform well overall, the Federal Reserve has indicated it will continue to gradually raise interest rates,” Monaco said. “The Fed has also indicated that future policy moves are very data-determined. So the Fed is not on a set path, unless the economy plays out as it projects. It has halted plans before—it was widely thought that the Fed would raise interest rates in September, but policymakers indicated the financial market disruptions in the month—also related to China—had an impact on their thinking not to raise rates.”