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Daily Agenda: Yellen Indicates a Rate Hike Is Coming

Fed Chair believes rates will rise in 2015; Chinese President to announce new carbon-emissions plan; core CPI contracts in Japan

In a highly publicized speech at the University of Massachusetts at Amherst Thursday evening, Federal Reserve Chair Janet Yellen clearly reiterated her stance that a rate hike before year-end remains likely, before cutting her speech short apparently due to a minor illness. Before her departure, the central bank chair also assured listeners that, although Fed policymakers stand vigilant, she and her colleagues do not anticipate a contagion spreading from emerging markets to the domestic U.S. economy. Perhaps most critically, Yellen articulated the need for a gradual approach to tightening as the job-market recovery remains fragile. The message of greater certainty resonated with markets, with equity indices rising in Europe and developed Asia.

Xi to unveil carbon-emissions plan. China’s president Xi Jinping is expected to use today’s meeting with President Barack Obama in Washington D.C. to unveil a new series of control measures for greenhouse gas emissions. The plan is expected to be based on cap-and-trade proposals designed and promoted by U.S. academics and supported by the White House.

Core CPI contracts in Japan. On Friday data released by Japan’s Statistics Bureau indicated that core consumer-price-index levels, which exclude fuel and food components, contracted on a month-over-month basis in August. Though in line with forecasts, this is the first such contraction since April 2013 and underscores challenges facing the government and Bank of Japan just days after calls for fresh reforms by Prime Minster Shinzo Abe.

Vote to avoid shutdown in Washington. A procedural vote has been scheduled for Monday in the U.S. Senate that will extend funding for federal operations past the looming September 30 deadline. The legislation under consideration is not expected to include provisions to cut funding for social programs, notably Planned Parenthood, opposed by some Congressional Republicans. Some members had demanded that vote after House Speaker John Boehner proposed presenting the controversial provisions in a separate bill.

Albertsons files for IPO. With over 2,000 locations throughout the U.S., supermarket chain Albertsons this week filed with the Securities & Exchange Commission to go public, with an initial targeted capital raise of over $1.8 billion. Albertsons’ owner, New York-based private equity giant Cerberus Capital Management, acquired rival chain, Safeway, in a $9 billion transaction last year, and merged the two into the second-largest U.S. grocer.

Brazil defends currency. The Brazilian real reached an intraday low of 4.24 per U.S. dollar on Thursday before central bank Governor Alexandre Tombini made a surprise announcement that bank reserves would be used to defend the currency. Despite a rebound, the real remains down over 35 percent versus the dollar year-to-date, as official forecasts call for the Brazilian economy to contract by nearly 3 percent in 2015.

Portfolio Perspective: China Systemic Risk—the Sequels

During the summer of 2014, a sharp contraction in bank lending and concurrent rise in non-performing loans triggered fears about the Chinese economy. One estimate of the systemic risk from the financial sector exceeded $575 billion, a level greater than that of more mature markets in the U.S., Japan and Europe (which faced its own crisis). China fears largely subsided by the end of 2014, in part due to three bulwarks of the Chinese economy: sizeable foreign exchange reserves, solid economic growth, and the government’s willingness to pull any policy lever to maintain stability.

The summer of 2015 witnessed a more searing flare-up of systemic risk triggered largely by the 30 percent decline in Chinese equity prices. Relative to 2014, systemic risk rose by 15 percent. Warning bells began ringing for institutional investors, many of whom seemed ready to hit their panic buttons.

That seems premature. In the short term, the three bulwarks available to China last year remain sound. China may have spent billions of U.S. dollars in just the past two months, but at $4.1 trillion the country sits on a pile of reserves bigger than in 2014. Chinese growth may have slowed, but economists forecast it will contribute more to 2015 global GDP growth than the U.S., Japan and Germany combined. The Chinese government’s frenzied response to the stock market crash appeared suboptimal, but it successfully dampened short-term volatility.

Longer term, the challenges facing the Chinese economy seem more foreboding. Foreign reserves are exhaustible. Slower economic growth may not satisfy a country accustomed to faster quality-of-life improvements. Policies imposed to manage the crisis may fertilize moral hazard in the financial sector and elsewhere. Even if hitting the panic button proves premature, the financial crisis history suggests that institutional investors should prepare for multiple sequels to this summer’s turbulent story.

Jeffrey N. Saret is head of thematic research for Two Sigma Investments in New York.

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