Kowtow To The Fed And Imf

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di Walter Snyder, Swiss Financial Consulting

The IMF will take a decision on whether to include the Chinese currency in the SDR basket at the end of November while the Fed will most likely raise its rates by 25 basis points at its December FOMC meeting. These decisions will have far-reaching effects on the global economy, which is experiencing a slowdown due to collapsing commodity prices stemming from an excess of supply and manufacturing overcapacity in China.

The efforts of Beijing to raise the status of the renminbi will mean that central banks will start using the redback as a reserve currency and commercial banks as well will be prone to stock up on yuan in their balance sheets. In order to meet the expected demand for yuan globally, the PBoC will provide even more liquidity to aid the ascent of its own currency. One can therefore expect an increase in the number of yuan-denominated bonds put on the market in tandem with more yuan in Forex markets. The PBoC will also probably bail out many companies defaulting on debt.

At the same time the decision of the Fed to raise interest rates will draw investors to purchase dollars in the expectation that the US dollar will appreciate against other currencies, especially the euro and the yen, exposed to QE by their respective central banks. Higher volatility in Forex trading is to be expected due to these factors. Trading in Forex will become somewhat difficult.

Investing in bonds will be tricky because the Fed will be raising rates slowly but continually unless a recession appears to be starting or worse. That means that bond yields will rise while bond prices on the secondary market fall. There is not much point in buying dollars to buy bonds whose prices will go down. One could expect equities to gain rather than bonds even though this is a contradiction.

Normally equities fall when interest rates rise. The problem is that with interest rates so low and the rises so carefully measured so as not to provoke panic, bond holders can look forward to years of pain. If companies go on with buyback campaigns to reward their executives and foreign investors choose to go for equities rather than lose capital with bonds that will fall in price, then normalcy will be hard to find. One begins to wonder what normal means in financial markets.

Add to this the overindebtedness of the US and a negative current accounts balance, which will be made worse by a strong dollar, along with the yuan raising its head over the SDR basket, the whole system will be characterized by instability heightened by the Fed trying to correct the effects of experimental measures. The shoals of unchartered waters await the container ships of the global economy.

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