26.05 Weekly Viewpoint : FOMC: A rate hike is on its way in June

FOMC: A rate hike is on its way in June, and the plan for a gradual and predictable reduction in the Fed’s securities holdings is almost ready, and likely to be in place by the end of the year……

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The minutes of the May meeting laid out the future path of the Fed’s two policy instruments: rates and balance sheet. For what concerns rates, as the assessment of the economy was broadly unchanged compared to March, “most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step”. The adverb “soon” was used in January as well to indicate the timing of the next hike, then implemented in March. Consensus for an impending hike is widespread, with a clear signal for a move in June. For what concerns the balance sheet, the staff provided a proposal to reduce securities holdings in a gradual and predictable manner, which met with the agreement of “nearly all” participants. Based on this approach, the Committee would announce a path of gradually increasing caps on the amounts of Treasury and MBS that would be allowed to run off each month, with the indication of reinvesting only the amounts in excess of those limits. As the caps are raised, reinvestments would be reduced, and the change in the Fed’s portfolio would increase as a result. The plan is to initially set the caps at “low” levels, and to subsequently raise them to their “fully phased-in” levels, which would be then maintained until the size of the balance sheet is normalised. The proposal is in line with the requisites of gradualness and predictability, considered essential to minimise risks of a new “taper tantrum”. The Committee also signalled that the “Policy Normalization Principles and Plans” document will be updated “soon”: the operational details of the reinvestment plan could be published already in June. The Committee will keep discussing plans for the reduction of its portfolio at its next meeting. One element that is still missing is the final size of the balance sheet and of excess reserves. According to “nearly all” participants, if the economy and the path of the federal funds rate evolve as currently expected, “it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year”. We confirm our forecast for a rate hike in June, followed by another in September, and then by a pause during which the Fed will prepare the tapering of repurchases.

OPEC meeting in line with expectations: we confirm our forecast for the price of Brent oil to stay in a narrow range at around USD 55 per barrel in 2H 2017.

The much-anticipated meeting in Vienna between OPEC member countries and non-OPEC allies brought no significant developments compared to the comments released over previous days by important representatives of the cartel. A nine-month extension of production cuts was announced, and a further three-month extension may be considered if, in March 2018, global reserves will have not yet returned in line with the five-year average. Nigeria and Libya will continue to be exempt, whereas Iran, that had been allowed to step up output following the removal of international sanctions, will be authorised to keep targeted output unchanged. Lastly, Equatorial Guinea (with an average oil output of just 0.27 million barrels per day) became the 14th OPEC member. As a whole, we view positively the strong cohesion displayed by the group both internally and with its non-OPEC allies, as also the reassurance that OPEC will take all the necessary action to restore inventories to levels in line with the defined target. However, the market did not react positively: after abandoning hope that the new agreement could add to current production cuts, oil quotations lost ground. We continue to expect the price of Brent oil to keep trading inside a relatively narrow range, averaging close to USD 55 in 2H 2017. Assuming implementation of the agreements stays close to the exceptionally high levels recorded since the beginning of the year, we consider upside risks as more likely in 3Q, due to the seasonal increase in domestic demand in Middle Eastern countries and in the United States. According to the comments made by the energy ministers of Nigeria and Iran, the interval deemed most adequate to restore stability to the oil market, stimulate investments in the sector, and at the same time support world consumption, is between 50 and 60 dollars per barrel. The USD 60 ceiling is seen as a major barrier.

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