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Did China's Devaluation Crush Yellen's Rate Hike Strategy

By Paul Brodksy of Macro Allocation, Inc.

The Yuan And The Fed

The overnight devaluation of the Yuan by the People’s Bank of China may not signal a change in the Fed actions this fall. As we suggested here, the Fed has quietly shifted its interest rate policy from one which primarily seeks to promote its domestic dual economic mandate (stable U.S. inflation and maximum employment) to one which primarily seeks to ensure the unilateral hegemony of the US Dollar. We concluded the Fed would raise rates this fall. In this regard, the Chinese devaluation last night may be considered a victory. For financial asset investors in the U.S. and around the world, the immediate question becomes whether the Fed will now relax its guidance and seeming intention to raise its Fed Funds target. We think the Fed will still raise rates.

The issue is dominance. While Chinese devaluation may be a victory, U.S. economic and foreign policies including global banking, trade, resource allocation and soft power rely on merciless execution of Dollar hegemony, especially at a time when the global economy appears to be rolling over (see here: We believe the Fed will be persuaded to consider the global picture and the beneficial second-order implications of a dominant currency on its formal domestic mandate, that being: in a global economy with declining output growth and zero-bound sovereign interest rates, an untouchable U.S. dollar would attract global wealth. U.S. bank deposits would increase regardless of deposit rates, U.S. Treasuries would be bid regardless of interest rates, and U.S. equity markets would see relative inflows regardless of potential economic slowing.

If we are right and the Fed hikes in September or December, it would then seem natural for it to signal a wait-and-see posture. In a contracting global economy, the competition among nations for capital can no longer be determined by relative growth, but, rather, by relative safety. This is serious stuff, and we do not expect U.S. policy makers to take America’s foot off the throat of economies posing threats to the established order in such an environment.