16.06.2017 - US: Fed raises key rate and announces balance sheet reduction

non-periodical

• Key rate range increased by 25 basis points to 1.00% - 1.25%
• Outlook for one more rate hike in 2017 and three more in 2018  
• Shrinking of balance sheet probably to start at one of the two forthcoming meetings  
• Starting volume of monthly reduction of USD 10 bn, increase to USD 50 bn until autumn    2018  
 
Market reaction: In response to the rate-setting decision, the dollar gained against the euro a good 1 cent reaching 1.115 EUR/USD. US government bonds of all maturities initially gained. By now however the yield of 2-year and 10-year bonds is back to where it was just before the FOMC meeting, i.e. 1.35% and 2.15% respectively.

Summary: As expected, the US central bank raised its key rate range by 0.25% to 1.00% - 1.25%. The decision was taken with only Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, voting against the raise. The accompanying statement only differed from the one from May in the remarks on the reinvestment of maturing bonds in the Fed’s bond portfolio. In this regard, it was announced that the bank would start to reduce the reinvestment of maturing bonds already this year to start the shrinking of its balance sheet. The economic situation was again judged as positive, arguing that the labour market continued to improve and private consumer spending as well as investment was increasing. Last months’ employment growth was described as solid. The risks to the short-term economic outlook were again characterised as roughly balanced.
With regard to the key interest-rate path, it was announced that the majority of the central bankers considered another interest hike by 0.25% as appropriate for this year. For 2018, three hikes were planned. The expected path of the key rate suggests three to four rate hikes for 2019. In consequence, the key rate would reach 2.00% to 2.25% at the end of 2018, and almost 3% at the end of 2019. The long-term neutral key rate was seen at 3.00%, just like in March.
The projections on the increase of the real gross domestic product and the inflation rate in 2018 and 2019 remained unchanged. However, the forecasts on the unemployment rate were reduced to 4.2% respectively for the end of 2018 and the end of 2019 (previously: 4.5%). This is 0.4 percentage point below the long-term neutral rate, which was decreased from 4.7% to 4.6%.
During the press conference, Ms. Yellen stressed repeatedly how important it was for the members of the monetary policy committee to reach the inflation target. Nevertheless, she also stated that the recently rather weak inflation data were mainly driven by one-off effects in prices for mobile phone services and certain medications. These weakening effects, however, would no longer be considered in the spring 2018 calculation of the inflation rate.
President Yellen also clarified two times that she already considered the labour market to be tight, which was supported by various indicators.
Since the plan was to start shrinking the Fed’s balance sheet already this year, Ms. Yellen said that this could be launched relatively soon. It is already clear how this should be done. First, the rein-vestment of maturing US government bonds will be reduced by USD 6 bn. In terms of maturing mortgage-backed securities, the reduction will initially be USD 4 bn. Every three months, the amounts will be increased by USD 6 bn or USD 4 bn respectively, until an amount of USD 30 bn is reached for the government bonds and USD 20 bn for mortgage-backed securities.

Assessment: In our view, the communication of Fed President Yellen can be considered as hawkish when compared to previous announcements. She did stress repeatedly the importance of reaching the inflation target, but also clarified various times that the recently rather weak inflation data should not be overestimated, as they mainly resulted from one-off effects.
Her characterization of the labour market as tight is absolutely new. So far, she had always referred to an existing potential for improvement. Now, her statement implies that every improvement on the labour market would mean an overheating that could lead to undesired effects in the medium or long term, such as a sudden increase in the inflation pressure. The fact that the inflation is currently low does not rule out any noticeable rise in the future. The possibility for such an increase rises with every further reduction in the unemployment rate. This is why Ms. Yellen alerted again how dangerous it would be not to normalise the monetary policy in due time and cautiously, as the key rate may need to be increased rapidly, finally leading to a recession.
From Ms. Yellen’s claim that the reduction of the balance sheet could start “relatively soon” we deduce that the go-ahead could be given already at the next FOMC meeting at the end of July or the one in September. The shrinking of the balance sheet could then start in August or October. The aforementioned amount for starting the reduction with a total USD 10 bn per month is at the upper end of our expectations. The final reduction volume of USD 50 bn planned to be reached in summer or autumn of 2018 is even clearly surpassing our expectations. The halving of the balance sheet total to about USD 2.25 trn, which we consider to be realistic, would then be reached already in the course of 2021, and not at the end of 2022/the beginning of 2023.
We anticipate the Fed to raise the key rate only one more time this year, namely in December. However, we do not foresee an interest hike in September, as this will be the time when the shrinking of the balance sheet will be initiated. Nevertheless, we anticipate three rate hikes instead of two in 2018.

Recommendation: If the Fed increases the key rate until the end of 2018, as had been recently indicated, it would reach 2.0% - 2.25%; that is the current level of the 10-year government bond yield. This would be absurd, as there is currently no indication suggesting that the key rate could not continue to increase. We believe that the market is focusing too much on the weak inflation development, which is totally irrelevant in view of an already overstretched labour market and the enduring risk of further heating the economy through an expansive fiscal policy in the next years. There are currently no risk of disinflation or deflation. Moreover, it is likely that the price pressure will quickly increase once a certain point of overstretching the labour market is reached. Additionally, the supply of long-term government bonds will considerably increase in the next quarters owing to the Fed’s balance shrinking. In our view, this suggests an increase in the 10-year US government bond yield in the coming months.


 
Risk notifications and explanations
Warnings:
•    Figures on performance refer to the past. Past performance is not a reliable indicator for future results and the de-velopment of a financial instrument, a financial index or a securities service. This is particularly true in cases when the financial instrument, financial index or securities service has been offered for less than 12 months. In particular, this very short comparison period is not a reliable indicator for future results.
•    Performance of a financial instrument, a financial index or a securities service is reduced by commissions, fees and other charges, which depend on the individual circumstances of the investor.
•    The return on an investment in a financial instrument, a financial or securities service can rise or fall due to ex-change rate fluctuations.
•    Forecasts of future performance are based purely on estimates and assumptions. Actual future performance may deviate from the forecast. Consequently, forecasts are not a reliable indicator for future results and the develop-ment of a financial instrument, a financial index or a securities service.

A description of the concepts and methods used in the preparation of financial analyses is available under: www.raiffeisenresearch.com/concept_and_methods.

Detailed information on sensitivity analyses (procedure for checking the stability of potential assumptions made in the context of financial analyses) is available under:
www.raiffeisenresearch.com/sensitivity_analysis.

Disclosure of circumstances and interests which may jeopardise the objectivity of RBI (as per Sec 48f [5] and [6] of the Stock Exchange Act): www.raiffeisenresearch.com/disclosuresobjectivity

Detailed information on recommendations concerning financial instruments or issuers disseminated during a period of 12 month prior to this publication (acc. to Art. 4 (1) i) Commission Delegated Regulation (EU) 2016/958 of 9.3.2016) is available under: https://raiffeisenresearch.com/web/rbi-research-portal/recommendation_history


Disclosure aspects which may jeopardise the objectivity of RBI:
1. Raiffeisen Bank International AG or a natural person involved in the preparation of the financial analysis owns a net long or short position exceeding the threshold of 0,5 % of the total issued share capital of the issuer; in the case the threshold is exceeded a statement to that effect specifying whether the net position is long or short is provided.

2. The issuer holds more than 5% of the entire issued share capital of Raiffeisen Bank International AG.

3. Raiffeisen Bank International AG or one of its affiliated legal entities is a market maker or specialist or a designated sponsor or stabilisation manager or liquidity provider in financial instruments of the issuer.

4. During the previous 12 months, Raiffeisen Bank International AG or one of its affiliated legal entities played a major role (e.g. as lead manager or co-lead manager) in any publicly disclosed offer of financial instruments of the issuer.

5. An agreement relating to the provision of services of investment firms set out in Sections A (investment services and activities) and B (ancillary services) of Annex I of Directive 2014/65/EU of the European Parliament and of the Council has been in effect during the previous 12 months between Raiffeisen Bank International AG or one of its affiliated legal entities and the issuer or such agreement has given rise during the same time period to the payment of a compensation or to the promise to get compensation paid for such services; in such cases, a disclosure will only be made if it would not entail the disclosure of confidential commercial information.

6. Raiffeisen Bank International AG or one of its affiliated legal entities has entered into an agreement with the issuer on the provision of investment recommendations.

7. The responsible analyst or a person involved in the production of the financial analysis owns financial instruments of the issuer which she/he analyses.

8. The responsible analyst or a person involved in the production of the financial analysis is a member of the executive board, the board of directors or supervisory board of the issuer which she/he analyses.

9. The responsible analyst or a natural or legal person involved in the production of the financial analysis, received or acquired shares in the issuer she/he analyses prior to the public offering of such shares. The price at which the shares were acquired and the date of acquisition will be disclosed.

10. The compensation of the responsible analyst or a natural or legal person involved in the production of the financial analysis is (i) linked to the provision of services of investment firms set out in Sections A (investment services and activities) and B (ancillary services) of Annex I of Directive 2014/65/EU of the European Parliament and of the Council provided by Raiffeisen Bank International AG or one of its affiliated legal entities resp. is (ii) linked to trading fees, that Raiffeisen Bank International AG or one of its affiliated legal entities receives.

11. If not already disclosed in 1 -10: Raiffeisen Bank International AG or one of its affiliated legal entities resp. the relevant analyst or a natural or legal person involved in the production of the financial analysis discloses all relationships, circumstances or interests that may reasonably be expected to impair the objectivity of the financial analysis, or which represent a substantial conflict of interest concerning any financial instrument or the issuer to which the recommendation directly or indirectly relates. The relationships, circumstances or interests include for example significant financial interests with respect to the issuer or other received incentives for taking into consideration third party interests.

Interests or conflict of interests (as described in the preceding paragraph) of persons belonging to one of Raiffeisen Bank International AG’s affiliated legal entities are known or could reasonably have been known to the persons involved in the production of the financial analysis.

The same applies to interests or conflict of interests of persons who, although not involved in the production of the financial analysis, have or could reasonably be expected to have access to the financial analysis prior to its publication.


Bonds

Distribution of short term recommendations (preceding 3 months prior to this publication)

 

Recommendation    Basis: all analysed Government bonds
Buy    23%
Hold    63%
Sell    14%
Not rated    0%
 
Outright: Recommendations concerning financial instruments or issuers (disseminated during a period of 12 month prior to
this publication), which differ from recommendations made in this publication with a recommendation horizon of 1-4 months
Date    10J US Treasury
02.06.2017    Sell
26.05.2017    Sell
07.04.2017    Sell
10.03.2017    Hold
03.03.2017    Hold
13.01.2017    Sell
16.12.2016    Hold
25.11.2016    Hold
11.11.2016    Hold
23.09.2016    Sell
05.09.2016    Sell
01.07.2016    Sell

Source: RBI/Raiffeisen RESEARCH  
 

Disclaimer Financial Analysis

Responsible for this publication: Raiffeisen Bank International AG („RBI“)

RBI is a credit institution according to §1 Banking Act (Bankwesengesetz) with the registered office Am Stadtpark 9, 1030 Vienna, Austria.

Raiffeisen RESEARCH is an organisational unit of RBI.

Supervisory authority: As a credit institution (acc. to § 1 Austrian Banking Act; Bankwesengesetz) Raiffeisen Bank International AG is subject to the supervision by the Austrian Financial Market Authority (FMA, Finanzmarktaufsicht) and the National Bank of Austria (OeNB, Oesterreichische Nationalbank). Additionally, RBI is subject to the supervision by the European Central Bank (ECB), which undertakes such supervision within the Single Supervisory Mechanism (SSM), which consists of the ECB and the national responsible authorities (Council Regulation (EU) No 1024/2013 - SSM Regulation). Unless set out herein explicitly otherwise, references to legal norms refer to norms enacted by the Republic of Austria.

This document is for information purposes and may not be reproduced or distributed to other persons without RBI’s permission. This document constitutes neither a solicitation of an offer nor a prospectus in the sense of the Austrian Capital Market Act (Kapitalmarktgesetz) or the Austrian Stock Exchange Act (Börsegesetz) or any other comparable foreign law. An investment decision in respect of a financial instrument, a financial product or an investment (all hereinafter “product”) must be made on the basis of an approved, published prospectus or the complete documentation for such a product in question, and not on the basis of this document.

This document does not constitute a personal recommendation to buy or sell financial instruments in the sense of the Austrian Securities Supervision Act (Wertpapieraufsichtsgesetz). Neither this document nor any of its components shall form the basis for any kind of contract or commitment whatsoever. This document is not a substitute for the necessary advice on the purchase or sale of a financial instrument, a financial product or advice on an investment. In respect of the sale or purchase of one of the above mentioned products, your banking advisor can provide individualised advice suitable for investments and financial products.

This analysis is fundamentally based on generally available information and not on confidential information which the party preparing the analysis has obtained exclusively on the basis of his/her client relationship to a person.

Unless otherwise expressly stated in this publication, RBI deems all of the information to be reliable, but does not make any assurances regarding its accuracy and completeness.

In emerging markets, there may be higher settlement and custody risk as compared to markets with established infrastructure. The liquidity of stocks/financial instruments may be influenced, amongst others, by the number of market makers. Both of these circumstances can result in elevated risk in relation to the safety of investments made in consideration of the information contained in this document.

The information in this publication is current as per the latter's creation date. It may be outdated by future developments, without the publication being changed.

Unless otherwise expressly stated (www.raiffeisenresearch.com/special_compensation), the analysts employed by RBI are not compensated for specific investment banking transactions. Compensation of the author or authors of this report is based (amongst other things) on the overall profitability of RBI, which includes, inter alia, earnings from investment banking and other transactions of RBI. In general, RBI forbids its analysts and persons reporting to the analysts from acquiring securities or other financial instruments of any enterprise which is covered by the analysts, unless such acquisition is authorised in advance by RBI’s Compliance Department.

RBI has put in place the following organisational and administrative agreements, including information barriers, to impede or prevent conflicts of interest in relation to recommendations: RBI has designated fundamentally binding confidentiality zones. These are typically units within credit institutions, which are isolated from other units by organisational measures governing the exchange of information, because compliance-relevant information is continuously or temporarily handled in these zones. Compliance-relevant information may fundamentally not leave a confidentiality zone and is to be treated as strictly confidential in internal business operations, including interaction with other units. This does not apply to the transfer of information necessary for usual business operations. Such transfer of information is limited, however, to what is absolutely necessary (need-to-know principle). The exchange of compliance-relevant information between two confidentiality zones may only occur with the involvement of the Compliance Officer.

SPECIAL REGULATIONS FOR THE UNITED KINGDOM OF GREAT BRITAIN AND NORTHERN IRELAND (UK):
This document does not constitute either a public offer in the meaning of the Austrian Capital Market Act (Kapitalmarktgesetz; hereinafter „KMG“) nor a prospectus in the meaning of the KMG or of the Austrian Stock Exchange Act (Börsegesetz). Furthermore, this document does not intend to recommend the purchase or the sale of securities or investments in the meaning of the Austrian Supervision of Securities Act (Wertpapieraufsichtsgesetz). This document shall not replace the necessary advice concerning the purchase or the sale of securities or investments. For any advice concerning the purchase or the sale of securities of investments kindly contact your RAIFFEISENBANK. This publication has been either approved or issued by RBI in order to promote its investment business. Raiffeisen Bank International AG (“RBI”), London Branch is authorised by the Austrian Financial Market Authority and subject to limited regulation by the Financial Conduct Authority (“FCA”). Details about the extent of its regulation by the FCA are available on request. This publication is not intended for investors who are Retail Customers within the meaning of the FCA rules and shall therefore not be distributed to them. Neither the information nor the opinions expressed herein constitute or are to be construed as an offer or solicitation of an offer to buy (or sell) investments. RBI may have affected an Own Account Transaction within the meaning of FCA rules in any investment mentioned herein or related investments and/or may have a position or holding in such investments as a result. RBI may have been, or might be, acting as a manager or co-manager of a public offering of any securities mentioned in this report or in any related security.

SPECIFIC RESTRICTIONS FOR THE UNITED STATES OF AMERICA AND CANADA: This document may not be transmitted to, or distributed within, the United States of America or Canada or their respective territories or possessions, nor may it be distributed to any U.S. person or any person resident in Canada, unless it is provided directly through RB International Markets (USA) LLC (“RBIM”), a U.S. registered broker-dealer, and subject to the terms set forth below.

SPECIFIC INFORMATION FOR THE UNITED STATES OF AMERICA AND CANADA: This research document is intended only for institutional investors and is not subject to all of the independence and disclosure standards that may be applicable to research documents prepared for retail investors. This report was provided to you by RB International Markets (USA) LLC (RBIM), a U.S. registered broker-dealer, but was prepared by our non-U.S. affiliate Raiffeisen Bank International AG (RBI). Any order for the purchase or sale of securities covered by this report must be placed with RBIM. You can reach RBIM at 1177, Avenue of the Americas, 5th Floor, New York, NY 10036, phone +1 212-600-2588. This document was prepared outside the United States by one or more analysts who may not have been subject to rules regarding the preparation of reports and the independence of research analysts comparable to those in effect in the United States. The analyst or analysts who prepared this research (i) are not registered or qualified as research analysts with the Financial Industry Regulatory Authority (“FINRA”) in the United States, and (ii) are not allowed to be associated persons of RBIM and are therefore not subject to FINRA regulations, including regulations related to the conduct or independence of research analysts.

The opinions, estimates and projections contained in this report are those of RBI only as of the date of this report and are subject to change without notice. The information contained in this report has been compiled from sources believed to be reliable by RBI, but no representation or warranty, express or implied, is made by RBI or its affiliated companies or any other person as to the report’s accuracy, completeness or correctness. Securities which are not registered in the United States may not be offered or sold, directly or indirectly, within the United States or to U.S. persons (within the meaning of Regulation S under the Securities Act of 1933 [“the Securities Act”]), except pursuant to an exemption under the Securities Act. This report does not constitute an offer with respect to the purchase or sale of any security within the meaning of Section 5 of the Securities Act and neither shall this report nor anything contained herein form the basis of, or be relied upon in connection with, any contract or commitment whatsoever. This report provides general information only. In Canada it may only be distributed to persons who are resident in Canada and who, by virtue of their exemption from the prospectus requirements of the applicable provincial or territorial securities laws, are entitled to conduct trades in the securities described herein.

EU REGULATION NO 833/2014 CONCERNING RESTRICTIVE MEASURES IN VIEW OF RUSSIA’S ACTIONS DESTABILISING THE SITUATION IN UKRAINE

Please note that research is done and recommendations are given only in respect of financial instruments which are not affected by the sanctions under EU regulation no 833/2014 concerning restrictive measures in view of Russia's actions destabilising the situation in Ukraine, as amended from time to time, i.e. financial instruments which have been issued before 1 August 2014.

We wish to call to your attention that the acquisition of financial instruments with a term exceeding 30 days issued after 31 July 2014 is prohibited under EU regulation no 833/2014 concerning restrictive measures in view of Russia's actions destabilising the situation in Ukraine, as amended from time to time. No opinion is given with respect to such prohibited financial instruments.

INFORMATION REGARDING THE PRINCIPALITY OF LIECHTENSTEIN: COMMISSION DIRECTIVE 2003/125/EC of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest has been incorporated into national law in the Principality of Liechtenstein by the Finanzanalyse-Marktmissbrauchs-Verordnung.

If any term of this Disclaimer is found to be illegal, invalid or unenforceable under any applicable law, such term shall, insofar as it is severable from the remaining terms, be deemed omitted from this Disclaimer. It shall in no way affect the legality, validity or enforceability of the remaining terms.

Imprint
Information requirements pursuant to the Austrian E-Commerce Act

Raiffeisen Bank International AG
Registered Office:
Am Stadtpark 9, 1030 Vienna
Postal address:
1010 Vienna, POB 50
Phone: +43-1-71707-0
Fax: + 43-1-71707-1848


Company Register Number:
FN 122119m at the Commercial Court of Vienna

VAT Identification Number:
UID ATU 57531200

Austrian Data Processing Register:
Data processing register number (DVR): 4002771

S.W.I.F.T.-Code:
RZBA AT WW

Supervisory Authorities:
As a credit institution (acc. to § 1 Austrian Banking Act; Bankwesengesetz) Raiffeisen Bank International AG is subject to the supervision by the Austrian Financial Market Authority (FMA, Finanzmarktaufsicht) and the National Bank of Austria (OeNB, Oesterreichische Nationalbank). Additionally, RBI is subject to the supervision by the European Central Bank (ECB), which undertakes such supervision within the Single Supervisory Mechanism (SSM), which consists of the ECB and the national responsible authorities (Council Regulation (EU) No 1024/2013 - SSM Regulation). Unless set out herein explicitly otherwise, references to legal norms refer to norms enacted by the Republic of Austria.

Membership:
Austrian Federal Economic Chamber, Federal Bank and Insurance Sector, Raiffeisen Association


Statement pursuant to the Austrian Media Act

Publisher and editorial office of this publication
Raiffeisen Bank International AG
Am Stadtpark 9, A-1030 Vienna

Media Owner of this publication
Raiffeisen RESEARCH – Verein zur Verbreitung von volkswirtschaftlichen Analysen und Finanzmarktanalysen
Am Stadtpark 9, A-1030 Vienna

Executive Committee of Raiffeisen RESEARCH – Verein zur Verbreitung von volkswirtschaftlichen Analysen und Finanzmarktanalysen:
Mag. Peter Brezinschek (Chairman), Mag. Helge Rechberger (Vice-Chairman)

Raiffeisen RESEARCH – Verein zur Verbreitung von volkswirtschaftlichen Analysen und Finanzmarktanalysen is constituted as state-registered society. Purpose and activity are (inter alia), the distribution of analysis, data, forecasts and reports and similar publications related to the Austrian and international economy as well as financial markets.

Basic tendency of the content of this publication
- Presentation of activities of Raiffeisen Bank International AG and its subsidiaries in the area of conducting analysis related to the Austrian and international economy as well as the financial markets.
- Publishing of analysis according to various methods of analyses covering economics, interest rates and currencies, government and corporate bonds, equities as well as commodities with a regional focus on the euro area and Central and Eastern Europe under consideration of the global markets.

Author: RBI Vienna: Jörg ANGELE; Matthias REITH
Editor: Matthias REITH, RBI Vienna

Producer of this publication
Raiffeisen Bank International AG
Am Stadtpark 9, A-1030 Vienna

Creation time of this publication: 16/06/2017 09:38 AM (CEST)
First Dissemination of this publication: 16/06/2017 09:40 AM (CEST)

Creation time of the publication in German: 16/06/2017 08:42 AM (CEST)
First Dissemination of the publication in German: 16/06/2017 08:45 AM (CEST)

Peter Brezinschek

Head of Raiffeisen Research
Raiffeisen Bank International AG
Am Stadtpark 9, 1030 Wien
Tel: +43-1-71707-1517
Fax: +43-1-71707-1848
peter.brezinschek@rbinternational.com
To the contact form