UBS On-Air: Paul Donovan Daily Audio 'Firing, not ceasing'
Paul Donovan argues that despite US claims of a ceasefire with Iran, continued military actions undermine that narrative, but markets are resilient due to optimism bias and Trump's low approval ratings limiting escalation risk. The market reaction remains muted as investors focus on US domestic politics and upcoming PCE data. Per the full note source, a 34% approval rating historically pressures politicians to moderate foreign policy.
What the desk is arguing
The desk frames the US ceasefire claim as inconsistent with ongoing military actions—US strikes on Iran, Iran on Kuwait, Israel on Lebanon, and Trump's threat to "blow up" Oman. Per the full note source, this volume of activity suggests "a lot of firing and relatively little ceasing." Markets have reacted negatively but in a muted fashion, supported by an optimism bias and resignation that such conflict is inevitable.
Key supporting evidence comes from Trump's approval rating dropping to 34%, according to The Economist tracker, lower than any point in either term and below Biden's nadir. A separate poll shows more voters blame Trump for the affordability crisis than any other factor. The desk suggests these political dynamics may restrain further escalation, as Republican lawmakers take note ahead of midterm elections.
The counterfactual the desk implicitly rejects is that the conflict could escalate to a full-scale war without political restraint. The alternative read—that Trump's approval rating immunizes him from political consequences—is dismissed because "approval ratings this low matter politically" and will influence congressional behavior.
Key takeaways
- 01US ceasefire claim contradicted by continued military actions by all parties
- 02Trump approval at 34% (Economist tracker) provides political check on escalation
- 03Market reaction muted due to optimism bias and resignation
- 04PCE data today expected to show consumer resilience despite higher gasoline prices
Market implications
The muted risk-off move suggests investors are pricing a low probability of sustained conflict. Watch crude oil for a break above recent highs if geopolitical tensions spike again. FX volatility may stay suppressed unless PCE data surprises or a new military incident occurs.
Risks to this view
A direct military confrontation involving US forces or a major supply disruption (e.g., Strait of Hormuz closure) would invalidate the benign outlook. Alternatively, a sharp improvement in Trump's approval rating could reduce political constraints, allowing more aggressive foreign policy.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Thursday the 28th of May. Unnamed US officials are claiming the ceasefire with Iran continues to hold.
The US fired on Iran yesterday, Iran fired on Kuwait, Israel fired on Lebanon, US President Trump threatened to, quote, blow up Oman. To an economist, this seems a lot of firing and relatively little ceasing. The firing back and forth has led to some market reactions.
But again, the optimism bias and a resigned sense that this sort of thing is perhaps inevitable has limited the extent of that reaction. One thing that may be supporting investor optimism is the fact that the war situation has not necessarily developed to Trump's advantage. In the Economist's tracking poll, Trump's approval rating hit 34%, the lowest approval of either term and lower than US President Biden ever reached.
A separate poll had more US voters blaming Trump for the cost of living crisis, more properly the affordability crisis, than any other cause by a substantial margin. Trump has said that this hostility will not deter the administration from its stance in the war, but simply put, markets don't believe that. Polls are partisan and distorted, but approval ratings this low matter politically.
Politicians and especially Republicans in Congress are likely to be taking note. The economics of the war are going to be in focus today with personal income and spending data and the personal consumer expenditure deflator out of the United States. The spending numbers are nominal and so they will include the effects of higher gasoline prices in April.
However, the expectation is that US consumers will continue to spend on non-oil items. They're not cutting back on spending to pay for gasoline, just as they did not cut back on spending to pay for the tariffs. Instead, the amount households save each month is being cut back and tax rebates are also being put to work in maintaining non-oil spending.
The result is that spending growth is likely to stay faster than income growth. First quarter GDP is scheduled to be revised, but GDP is A, unreliable in real time, B, an abstract concept for most ordinary citizens, and C, in the case of the United States, is likely to be increasingly divorced from the lived experience of US households. Higher oil prices can boost the value of US energy exports, raising GDP.
They also increase the inflation perceptions and the inflation experience of US households. On the inflation side, the US personal consumer expenditure deflator is expected to increase on the energy prices in April, but the core measure is not expected to accelerate too much. The core measure does include oil prices embedded in other goods, and the speed with which oil costs are being passed down the supply chain does mean that some of those embedded oil costs will already start to be visible.
As ever, the perception of inflation will differ from the reported headline because it's high frequency purchases that matter to perceptions. The personal consumer expenditure deflator doesn't actually tell us anything new about high frequency purchases prices, they've already been captured in the consumer price data. The deflator just weights things differently and doesn't place quite so much emphasis on the entirely fictional and thus invisible concept of owner's equivalent rent.
The list of central bank speakers on the calendar today is simply enormous. The US Federal Reserve's roster includes Fed President Williams, who is a sound economic voice. The ECB's list includes Srinabal, who will doubtless be demanding higher interest rates as soon as possible.
The Bank of England's list includes Deputy Governor Breedon, who has been talking an awful lot lately. That's all for today. Have a good day.
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