Highlight US Fed funds rate hike to take place as expected despite RMB devaluation, says Citi

by **Cals** Wed 12 Aug 2015, 18:58

Highlight
US Fed funds rate hike to take place as expected despite RMB devaluation, says Citi

SINGAPORE (Aug 12): Despite the fallout in global equity, bond and currency markets following the move by the People’s Bank of China to devalue the yuan by 2% on Aug 11, Citi believes the upcoming interest rate hike proposed by the US Federal Reserve will take place next month as expected.
“So far, things are on track for a lift off in September,” says Citi in an Aug 12 note.
“From a US perspective, we believe this policy gesture of loosening the RMB peg to the US dollar is another move in a series of recent attempts to bolster China's rapidly weakening growth. This latest move complements official interventions in China's equity markets,” Citi analysts write in their Aug 12 note.
“We consider this latest move as an attempt to contain China's slowdown from affecting activity in the region and globally and to stem concerns about the efficacy of China's financial liberalisation agenda.”
However, slowing growth in China, alongside declining oil prices and the strengthening greenback, are only “transitory factors” with temporary impact on the economy, Citi believes. Meanwhile, the Fed is likely to base its decision on a rate hike on more fundamental and improving trends, such as falling unemployment.
Moreover, direct trade flows between the US and China is relatively small, with the shipment of US goods to China representing just 7.7% out of total exports, according to Citi data. In comparison, exports of US goods to Canada and Mexico total 19% and 14.2% of total exports, respectively.
Still, Citi is cautioning its clients to watch out for signs of disorderliness in asset markets which could delay the Fed funds rate hike.
“This regime shift implies the beginning of a measured RMB depreciation,” Citi says. Consequently, it expects the RMB to weaken by 4.2% from Aug 11 levels to 6.5 against the USD over the next 12 months.
The brokerage also expects heightened volatility in the RMB and further rate cuts by the PBoC to stem capital outflows in the months ahead.