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What Does China's GDP Reading Mean for the Fed? Depends on Whether They Buy It



Federal Reserve officials, in justifying their decision to hold off on interest rate increases in September, placed an unusual emphasis on uncertainty surrounding China's economic outlook.

"The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets," Janet Yellen said during her post-meeting press briefing .

Given that focus, it makes sense to ask what the latest reading of China's GDP, which came in at 6.9 percent in the third quarter, means for the prospects of an interest rate hike from the Fed, which investors are increasingly betting may not take place until next year.

First, do you believe the data? This is not an irrelevant question given growing doubts among economists about the reliability of China's statistics.

Nicholas R. Lardy, senior fellow at the Peterson Institute for International Economics, has suggested such concerns are overdone, arguing that a pick-up in service sector growth has remained under the radar while the country's property and industrial slowdowns have grabbed all the headlines.

What we don't know is how much faith Fed officials have in the official data. Presuming they do, the latest GDP reading should provide some comfort that its economy is indeed headed for a much sought-after "soft landing," which would open the window to a Fed rate increase. However, if Fed officials are paying attention to a broader range of Chinese indicators like prices, imports, and exports, they are likely to have a less sanguine view of the outlook, particularly since these are the sectors with greater external linkages.

Importantly, the Fed has indicated it is not just worried about a China slowdown per se but also about its potential ripple effects on other emerging markets, which are already facing headwinds including deep recessions in Russia and Brazil.

"There is a risk that the intensification of international crosscurrents could weigh more heavily on US demand directly, or that the anticipation of a sharper divergence in US policy could impose restraint through additional tightening of financial conditions," said Fed Board Governor Lael Brainard in a speech this month.

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