March 24, 2017
The financial markets have been keenly focused on the progress of the Obamacare replacement bill constructed by Speaker Paul Ryan, and championed by President Trump, that has struggled to find enough support to pass a predominantly Republican House. The difficulty that the Republicans have had on repealing and replacing Obamacare has made many observers question their ability to accomplish tax reform in a reasonable timeframe. While this has the potential to have meaningful short-term market implications, we are also watching China’s reaction to last week’s Fed rate hike. Rate increases by the Federal Reserve put pressure on China to also increase rates to support the yuan. The yuan has been eroding against the dollar since the middle of 2014. The Chinese have spent roughly 1 trillion dollars in foreign reserves in an attempt to support the yuan. Additionally, as China cuts back on infrastructure spending in an effort to transition toward a more consumer-led economy, it is counting on the private sector to ameliorate the economic slowdown. Rising rates would be an impediment to private sector growth. Although the Chinese have raised some secondary rates after the Fed hike, they have left the benchmark 1-year lending rate unchanged. We think China’s reaction to rising short rates in the U.S. has very important implications for financial markets.