China Climbs Back Up Janet Yellen's Worry List

China GDP: Expecting the Unexpected

  • Yellen cited China as a reason to hold steady last September
  • Shanghai stocks tumble as worries mount over capital outflows

When Federal Reserve Chair Janet Yellen looks for an update on China at this week’s policy meeting, she’ll find little reason for cheer.

QuickTake The Fed Lifts Off

The Shanghai Composite Index has tumbled to a 13-month low as a rout that started in the middle of 2015 shows no signs of easing up. Capital is leaving at a record pace. Readings on the economy remain mixed, with expansion last quarter at the slowest pace since 2009. And then there’s the yuan: down about 5 percent over the past year against the dollar, and concerns of a steeper devaluation are persisting.

Taken together, the signals from the world’s second-largest economy bolster those calling for the U.S. central bank to hold off from another interest-rate increase, said David Mann, chief Asia economist at Standard Chartered Plc in Singapore.

“The Fed has to pay more attention than ever before to what is happening in China,” Mann said. “China’s market wobbles and U.S. stock indices’ recent performance add to the list of reasons to expect a move dovish outcome.”

Yellen and her fellow officials are expected to hold rates steady at their first gathering of the year, a two-day meeting that concludes Wednesday. Investors will look for any commentary around risks from emerging economies and China in particular in the statement to be released at 2 p.m. in Washington. Overnight, the Shanghai Composite Index dropped 0.5 percent, extending a 6.4 percent plunge on Tuesday.

By contrast, a period of relative calm in China’s markets toward the end of 2015 helped the Fed to raise rates for the first time in almost a decade. That was after Yellen in September said China’s market turmoil had been among reasons to stay on hold.

Out of Step

To be sure, the panic seen on China’s markets is viewed as out of step with the underlying economy, which is expected to undergo another modest slowdown this year. Gross domestic product will expand 6.5 percent in 2016, compared with last year’s 6.9 percent, according to the latest survey of economists by Bloomberg News.

The Fed’s September response to that round of China-induced turmoil has become increasingly viewed as an overreaction. For that reason, Yellen will be intent on looking through financial market reactions and concentrating on China’s real economy, according to Mickey Levy, the New York-based chief economist for the U.S. and Asia at German bank Berenberg.

“Having made a blunder in September, they’ll be more careful this time around and not be so reactionary to the financial turmoil,” Levy said. “They’ll be more focused on the fundamentals.”

The Fed’s “baseline” view of China is that the economy is clearly slowing, but with tremendous uncertainty over how much it’s slowing, he said.

Yet the lingering perception from China’s market woes is fueling jitters around the world.

“The general risk-off sentiment that it seems to have triggered must be a concern to the Fed as it tightens financial conditions in the U.S.,” said Richard Jerram, the chief economist at Bank of Singapore.

Capital outflows hit $1 trillion in 2015, more than seven times the drain in 2014, based on Bloomberg Intelligence data dating back to 2006. While the consumer and services sectors continue to hold up well, their strength isn’t enough to offset a slowdown in manufacturing and exports.

Signaling Problem

Another China problem: transparency. A growing chorus of current and former policy makers, including International Monetary Fund Managing Director Christine Lagarde, have called on China to be more explicit about its exchange-rate policy. That might be easier said than done in a centrally controlled economy.

“Who in China would do the signaling?” said Andy Xie, an independent economist who previously worked for the World Bank and Morgan Stanley. “The recent policy actions are pretty chaotic.”

Some Chinese policy makers put the blame for currency swings elsewhere. Vice President Li Yuanchao last week said the yuan’s recent depreciation was fueled by the Fed’s decision to raise interest rates.

Whoever is right, investors and policy makers are likely to remain cautious on China, Standard Chartered’s Mann said.

“Confidence has been hard hit since the start of January by worries over policy direction in China, specifically over whether there is a conscious effort to weaken the currency,” he said.