The Fed is watching China very, very closely right now
In prepared remarks set to be delivered to Congress on Wednesday morning, Fed chair Janet Yellen made a number of references to China, specifically how financial conditions in the world's second-largest economy could impact US financial conditions going forward.
"As is always the case, the economic outlook is uncertain," Yellen's remarks read.
"Foreign economic developments, in particular, pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign exchange value of the renminbi have intensified uncertainty about China's exchange rate policy and the prospects for its economy. This uncertainty led to increased volatility in global financial markets and, against the background of persistent weakness abroad, exacerbated concerns about the outlook for global growth."
And so the dynamic Yellen is basically outlining is one where fears about economic slowdowns could actually lead to those slowdowns.
China's economy, as is well known, has been slowing for years and at least in Yellen's view this is nothing that, on its own, should give market's pause.
But the impact that other financial developments - in this case it would be the crash in oil prices and the rally in the US dollar - are having on China could lead to further adverse conditions which then, in turn, could lead to more concerns about global growth, which could lead to slower growth.
Yellen again:
Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices provide some offset. Still, ongoing employment gains and faster wage growth should support the growth of real incomes and therefore consumer spending, and global economic growth should pick up over time, supported by highly accommodative monetary policies abroad. Against this backdrop, the Committee expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in coming years and that labor market indicators will continue to strengthen
[...]
These growth concerns, along with strong supply conditions and high inventories, contributed to the recent fall in the prices of oil and other commodities. In turn, low commodity prices could trigger financial stresses in commodity-exporting economies, particularly in vulnerable emerging market economies, and for commodity-producing firms in many countries. Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further.
Read Yellen's full remarks here, and we'll have complete coverage of Yellen's Q&A when she takes the mic at 10:00 a.m. ET.