The oil price and inflation are inherently linked, explaining why the Federal Reserve is watching both indicators like a hawk. However, with oil’s volatility catching many off-guards, how is this rollercoaster price saga affecting the Fed’s decision-making progress? We asked Ebele Kemery a name in the top professionals and expert fund managers what oil’s unpredictability means for rate hike plans and what to expect from ‘black gold’ this year
JP Morgan Asset Management
Fund manager and head of energy investing
- Oil will hit $45 by year-end
- Inflation to move in sync with energy prices
- Volatility has Fed’s hike plans on standby
- Barring an unlikely Opec cut or any prolonged geopolitical disruption, market conditions suggest that global oil inventories will continue to rise well into early 2017.
As such, oil prices will remain low for the remainder of the year. Rampant oversupply, uncertainty around global oil demand, Opec rhetoric and an increased correlation to macro sectors will cause prices to remain volatile. It is my expectation that crude will trade in a $25-45 range, exiting the year around $45 a barrel.
Weak oil prices have led to low energy costs for the consumer, keeping headline inflation low. Expected inflation, as measured by the Tips market, is low partly as a result of depressed energy prices and expectations of persistently low commodity prices for the foreseeable future. Break-evens across the curve remain correlated to energy prices, and as a result, spot and forward inflation will likely move in sync with energy prices.
In line with the Federal Reserve’s dual mandate of maximum employment and stable prices around 2%, monetary policy makers are trained to look through short-term energy price volatility to the longer-term trend.
However, the recent oil price volatility could affect the Fed’s decision to raise interest rates as it relates to risk asset volatility and financial conditions, both of which have stabilized in recent weeks, but have the potential to keep the Fed on hold from further policy normalization.
Core inflation – which excludes the volatile food and energy components – has been driven higher by service costs. Core CPI currently stands at 2.3% year-over-year. Despite acceleration in realized inflation, the Fed has taken a cautious approach to tightening. As a result of these tighter financial conditions, as well as softer inflation expectations as measured by Tips markets, they forecast two rate hikes this year – a significant downgrade from the start of the year.
Given the economic slowdown outside of the US, concerns arise around crude oil demand. Should demand disappoint, the oil market is likely to retest its lows for the year. It is possible that the Fed would refrain from any rate hikes if oil breaks its recent low of $26.05, as a renewed oil meltdown would push inflation expectations lower, blow out sovereign and corporate debt values, and rock the equity markets, similar to the price action seen earlier this year.
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