How a Fed Rate Hike Will Play Out After the Yuan Devaluation

Until this week, a Fed rate hike at the September FOMC meeting seemed more probable by the day.

U.S. Federal Reserve Chairwoman Janet Yellen had hinted for months that the U.S. central bank finally was ready to raise interest rates above zero for the first time since late 2008.

yuan and the dollar"I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate," Yellen said in a July speech in Cleveland.

As recently as Friday, job growth numbers roughly in line with expectations bolstered sentiment that a Fed rate hike would arrive in just over a month, at the Sept. 16-17 Federal Open Market Committee meeting.

But on Tuesday, the Chinese central bank decided to loosen its grip on the yuan, essentially devaluing the currency. The yuan fell 1.9% against the U.S. dollar - its biggest one-day fall since 1994 - and since has continued to slide. In three days, the yuan has slipped more than 3% against the dollar.

That gives the Fed something else to think about. A Fed rate hike now will make life even tougher for a lot of U.S. multinationals.

"China's move immediately makes the dollar stronger. That, in turn, further hamstrings U.S. exporters and worsens the trade imbalance with China. It also shifts the competitive advantage to Beijing," said Money Morning Chief Investment Strategist Keith Fitz-Gerald.

There's also some irony in the fact that China's action will have an impact similar to a Fed rate hike.

"China is doing Yellen's job," Fitz-Gerald said.

Western markets promptly interpreted the move as an effort by China to prop up its economy, raising anew concerns that China's economy is weakening. In fact, Fitz-Gerald said, the move plays into China's long-term strategy to have the yuan join the world's basket of reserve currencies.

But to Western financial minds, it means China's struggling. And the perception of a weaker Chinese economy (which will result in a weaker global economy) argues against a Fed rate hike that will makes U.S. companies less competitive.

So what's a Fed chairwoman to do?

"This takes the rate hike off the table for September," Fitz-Gerald said. But with the Federal Reserve now wanting to make a move, he thinks it likely the delay will last only until the following FOMC meeting in December.

But Fitz-Gerald said the timing of the Fed rate hike is not what's really important - it's how the Fed goes about it.

The Fed Rate Hike Forecast: Low and Slow

Long before this week's currency mayhem, Fitz-Gerald saw clues in Yellen's language that told him much more than when a Fed hike might take place.

"There's a lot of discussion about timing, but the real issue - the one to concentrate on - is the pace," Fitz-Gerald said. "I think Yellen is telegraphing the slowest rate normalization in recorded history. That says to me the Fed is involved for a long time and that there's going to be an upward bias for another five years - maybe even 10."

For investors, this is especially key, particularly when investing for the long term.

A long and slow pace of Fed rate hikes "means that stocks are going to have plenty of room and, more importantly, time to adjust to higher interest rates," Fitz-Gerald said. "There have been plenty of instances in history where a slow rise has actually been very, very good for stocks."

Meanwhile, the Chinese yuan devaluation is creating investing opportunities. Fitz-Gerald likes three in particular.

How to Profit from the Chinese Yuan Devaluation (and a Stronger Dollar)

"First, China's move begs you to 'buy' dollars," he said. "The easiest way to play this is to buy the PowerShares DB U.S. Dollar Index Bullish Fund (NYSE Arca: UUP). It's worth noting that if you already have U.S.-based companies in your portfolio, you've got this base covered indirectly. So this ETF is really gravy or a complimentary trade to your core holdings."

Next, Fitz-Gerald recommends one of Apple Inc.'s (Nasdaq: AAPL) biggest suppliers, Hon Hai Precision Industry Co. Ltd. (TPE: 2317).

"Hon Hai is part of the Foxconn Technology Group and has more than 1 million workers assembling iPhones, iPads, and other products including PCs, TVs, and gaming consoles," Fitz-Gerald said. "You'll have to do a little work to buy it, though, because it's on the Taiwan exchange. Still, don't let that deter you. The P/E is a low 9.15, according to Yahoo! Finance, and China's yuan instantly provides a kick to margins that will be related to the upcoming holiday season."

Fitz-Gerald also suggests investors look at energy infrastructure company Williams Co. Inc. (NYSE: WMB). A stronger dollar makes oil cheaper, one reason oil prices are low and many quality oil stocks are bargains. As global growth and global demand increase, so will profits at companies like Williams.

"The dividend is a healthy 4.70%, and it's got billions in capital investment projects coming online, the value of which is not yet reflected in the stock price," Fitz-Gerald said.

Plus, Williams is a possible acquisition target, with bids likely in the $63 to $64 range. That's roughly a 24% gain from where WMB is trading today, at $51.36.

Finally, Fitz-Gerald says investors need to be sure they don't underestimate China.

"Chinese bears have only been one thing consistently for 40 years - wrong," he said.

The Bottom Line: China's decision to devalue the yuan has disrupted the timetable for a Fed rate hike, but will not prevent it. But investors need to look beyond this single event. It's more important to focus on the pace of future Fed interest rate hikes while seeking opportunities to profit from the yuan devaluation.

Why China Acted Now: For years, the Chinese government had resisted calls to let market forces determine the value of the yuan. Then, with little warning, the Chinese central bank backed off from its strict policy for setting the yuan's value. Here's why the Chinese government changed its tune so quickly...

About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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