Market Ramblings: 03/03/2016

“I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations” ~St Louis Fed President Bullard

After a lukewarm January jobs number, February came through in a big way with 240,000 non-farm payroll jobs added. CPI and PCE are up in February. The labor force participation rate is up as well. The Philips-curve economists at the Fed now have all the data they need to JUSTIFY a rate hike in March.

Even the dollar is down against gold and the Yen. The dollar has risen against the Euro as the market tries to front run Mario Draghi’s bazooka.  As I stated in my previous post, I think Draghi will disappoint the markets, and the Euro could rally against the dollar, giving the Fed even more reasons to hike interest rates. In short, St. Louis Fed President Bullard is going to look like an idiot come March… unless a certain nation devalues its currency.

A Fed rate hike in March would accelerate the global trends that are leading to a global recession. The dollar would strengthen, commodity prices would continue to fall, dollar liquidity around the globe would shrink, capital flight out of emerging markets would accelerate and those deflationary pressures would come home to roost in the US.

It’s hard to imagine a worse environment for economic growth. And in a growth slowing environment, the economies with the largest and most unsustainable debt bubbles are the most vulnerable.

Of course I’m talking about China here. Arguably no country is more susceptible to the negative impacts of a strong dollar, and also no country is in a position to stop a Fed rate hike, which places China and the PBoC in an unique position.

If the PBoC was to devalue the Yuan like it did last August causing risk assets around the globe to sell off dramatically and depress commodity prices even further. Another Yuan devaluation would be the PBoC’s way of beating the Fed to the deflationary punch, but in this case, instead of the Yuan rising with the dollar, it would fall, easing the deflationary pressures in China.


The alternative is that the PBoC does nothing, the Fed hikes, and the Yuan rises with the dollar putting further deflationary pressures on China’s massive credit bubbles. As the bubbles burst, capital flight would accelerate, weakening the Yuan even further. The Fed rate hike would thus lead to an eventual weakening of the Yuan.

In both cases, China is screwed. There are no easy way outs and the Yuan is headed lower whether the PBoC wants it to or not. Therefore, weakening the Yuan to prevent a Fed rate hike would not only be a step in the right direction but also prevent the Fed from simultaneously draining further liquidity from China’s economy. I’m not saying that the PBoC will devalue the Yuan to prevent a Fed rate hike, I’m merely arguing that it is in their best interest to do so.

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