After all the excitement and hyper-analysis of the yuan devaluation, global markets have read Beijing's intervention in the currency market as China's attempt for further financial liberalization rather than a stimulus package or an all out currency war.
This is evident as most of the moves in the global major currency crosses, rates and equities have been reversed (excluding the Asian FX space). If China decides to devalue further in the coming weeks, then I will stand corrected and we will witness another round of very volatile choppy moves across the financial markets.
The focus will now shift back to when the US Federal Reserve will tighten monetary policy, for the first time in nine years. Due to the risk off nature of the China devaluation, markets have moved the implied probability of a September hike from roughly 60 percent to 50 percent since last Monday and 10-year US bond yields have fallen 13 basis points. Whether it was the Greek crisis or China now, the US Fed will need to understand that there will always be global factors which it can use as an excuse to delay monetary tightening. The next round of dreadful news flow can come out of Spain or Portugal, or an escalating of geopolitical tensions in the Middle East, or maybe another phase of capitulation in the Chinese equity markets. However, the Fed will soon have to look beyond these potential external risks if domestic fundamentals are suitable for a interest rate hike.
If Fed chief Janet Yellen is to stick to her 'data dependent' approach towards monetary tightening, there is absolutely no chance of a September liftoff. While US job creation data remains robust, wage inflation remains extremely weak. The Fed's favourite indicator to read wage pressures is the employment cost index (ECI). Data released two weeks ago showed that the ECI rose by 0.2 percent QoQ in 2Q15, down from 0.7 percent QoQ in 1Q15, with private industry ECI growth falling from 0.7 percent QoQ in 1Q15 to 0.0 percent in 2Q15.
A CLSA research notes that "While on a year-on-year basis, the employment cost index growth slowed from 2.6 percent YoY in 1Q15 to 2.0 percent YoY in 2Q15, the slowest annualised growth rate since 2Q14. The private sector ECI growth also slowed from 2.8 percet YoY to 1.9 percent YoY with the growth in the wages and salaries component decelerating from 2.8 percent YoY to 2.2 percent YoY. Further dashing the hopes of cyclical bulls, this was the smallest quarter-on-quarter gain in the ECI since 1982."
Capitulation in commodity prices, especially energy, will further add to global disinflationary pressures. Unless the Fed is looking at some other data which is signaling wage inflation, the possibility of a September rate hike looks remote.
(Vatsal Srivastava is consulting editor with IANS. The views expressed are personal. He can be reached at vatsal.sriv@gmail.com)
