Top of the Morning: CIO Strategy Snapshot - Holland days
The current market environment is characterized by a temporary calm as we approach the end of peak summer vacation season, which appears to be affecting trading volumes and volatility. According to Jason Draho from UBS, although the recent retail sales data was disappointing, a deeper analysis reveals that seasonal factors could have distorted the figures, suggesting that consumer spending remains dynamic. Per the full note source, continued strength in credit card spending indicates resilience in the consumer economy, which may influence the Fed's monetary policy trajectory moving forward.
What the desk is arguing
The desk posits that the prevailing calm in the markets might be short-lived, as pivotal economic data continues to unfold, influencing the Federal Reserve's monetary policy decisions. Per the full note source, retail sales figures may appear weaker at first glance, but adjustments for seasonal quirks, such as shifts due to Amazon Prime Day, dilute their negative implications.
Furthermore, trends in high-frequency data, particularly robust credit card spending, provide a more encouraging signal regarding consumer resilience, which could bolster economic fundamentals in the near term and affect the Fed's outlook on interest rates. These insights suggest the potential for future monetary tightening if economic activity remains sustained and inflation expectations persistently rise.
Where it sits in our coverage
We currently project a consensus target of 1.075 for the USD/EUR pair, with range forecasts sitting at a minimum of 1.04 and a maximum of 1.12. Specific targets from major banks include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns closely with the perspective offered by jpmorgan, reaffirming a bullish sentiment toward the USD, while showing some divergence from bofa, which holds a more conservative stance.
How other firms see it
Several firms, including jpmorgan and citi, reflect a similar optimistic outlook on the USD's performance against the EUR, suggesting that the dollar will likely remain strong if economic data continues to surprise to the upside. On the other hand, bofa takes a contrary approach, advocating a more cautious stance on the USD due to concerns over inflation moderation.
It's also worth noting that the trajectory of the EUR/USD pair is closely linked with the path of Fed interest rate policy adjustments, making it crucial to watch for any shifts in communication from the Fed or economic indicators that could affect this dynamic.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Recent economic data presents mixed signals for Fed policy, influenced by seasonal retail sales trends.
- 02High-frequency metrics, such as credit card spending, indicate a resilient consumer sector.
- 03Current sentiment among traders remains cautiously optimistic about the USD in relation to the EUR.
- 04Consistent inflation or strong consumer spending could drive further Fed rate hikes.
Market implications
Traders should monitor the strength of consumer spending and any signals from Fed communication, particularly any clues regarding interest rates. A key level to observe in the USD/EUR pair is 1.075, which is critical for maintaining bullish positions.
Risks to this view
Should inflation unexpectedly decline or consumer spending show signs of significant weakening, this would challenge the desk's bullish outlook for the USD and necessitate a reevaluation of current positions. Additionally, unexpected shifts in Fed guidance could catalyze volatility.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. We are in the homestretch of summer and peak vacation season which has contributed to relative market calm so far in August.
Investors did have to digest important economic data last week and their implications for Fed monetary policy. So joining me here on this Monday morning to discuss these topics and what it means for your portfolio. Glad to welcome back from UBS Chief Investment Office within UBS FSI, Head of Asset Allocation for the Americas, Jason Draho.
Jason, good Monday morning to you. Welcome back and thank you for joining our listeners and our clients here on this Monday morning. Good morning, Dan.
Happy Monday. Good to be here again. So with that, Jason, let's get right into it beginning with inflation and retail sales data which we did receive last week.
What does that data say about the state of the economy today? So the retail sales data, the headline number was bad, but there was some kind of caveats to that story. There were some seasonal quirks and that Amazon Prime Day happened in June this year versus July.
That boosted June at the expense of July, so on a year-over-year basis, that put through July the trend of disadvantage that hurt. The World Cup, you know, that's a lot of spending in June, so that likely maybe pulled forward some new travel expenditure in June from July. So again, sort of shifting from a calendar perspective, some of that spending makes look at July kind of a weaker than it otherwise would be.
You know, overall, the report was still mixed. It wasn't a good report, but it doesn't seem as bad as the headline data suggests. What's also relevant is that more high-frequency data, you know, the credit card spending continues to be quite strong that we haven't gone into August, not a notable slowdown.
There also appears to be evidence that the so-called K-shaped consumer economy is starting to morph into a C-shaped. So the K-shaped idea is that high-income consumers, their spending growth is rising rapidly. Low-income consumers' spending growth was much more temperate, barely growing at all, just real bifurcation in the economy.
What the more recent data suggests is that lower-income consumers are starting to increase their spending. You know, at a more significant rate to match, essentially, the growth rates of high-income consumers. So that bifurcation of the K, now you're seeing the bottom part of that K is tilting higher, hence the C-shape, or the term of C-shape.
And it's not due to, like, increased spending on savings. It looks like it's more kind of, you know, increased kind of, you know, wage growth for the, real wage growth for that bottom tier. This is a positive for the, you know, as I said, the fundamental driver that's going to be more lasting.
And that's positive for, you know, overall growth outlook. On the labor market data we got, you know, over a week ago, below expectations, but the three-month average of job growth, around 20,000, is kind of in line with what economists were thinking. This is the sort of trend level of job growth that we need in order for the unemployment rate to stay stable.
You add it all up, you know, and roll in also AI, cap-expending, which has been a big driver of growth this year, coming out of Q3 earnings, or Q2 earnings season, where the guidance was strong, and also companies are demonstrating some monetization benefits that reinforces this, you know, kind of a positive narrative on this AI investment that you point out. That should continue. So we're left with a growth environment, you know, not spectacular, but solid, likely to be around 2% the rest of the year.
And I can describe it as relatively benign. Pivoting to inflation, that's, you know, also was probably the better story last week. The inflation data came in basically in line with expectations, or even slightly below, which means that we've seen a kind of a clear rollover from the core inflation measures from their peak in May.
Now we have two months of improving data. Very solid indicators for August would suggest that August data should also be kind of in line, similar level, in line with expectations, and similar to the July data. If that's the case, then we have three months in a row of relatively good inflation data.
And some of the more structural factors, such as, you know, disinflation from Sheldon, which is a very, very strong indicator of inflation in the short term. And then, of course, inflation in the long term. So it looks like it's going to continue.
Wage growth is moderating. So longer term, that is not an inflationary policy, especially for kind of the services part of the economy. And once you look at other measures of kind of key inflation measures, besides some core PCE, which is what the Fed focused on, such as trimming inflation, things of that sort, I think the macro conditions are not golden locks.
It's not to say kind of inflation so much anymore. So it's kind of relatively benign. And benign is not a bad situation at all for the U.S. economy at this point in time.
Now, Jason, in terms of how this all translates to monetary policy, what does this latest batch of economic data mean for the Fed policy outlook from here? Well, in our view, it reinforces the view that the Fed is going to stay on hold this year, not hike rates. And the next move is more likely to be a cut than a hike starting the spring of next year.
The market price is a shift in that direction. As of this morning, on Monday morning, the market is priced at about a 30 percent chance of a hike in September, and a cumulative probability of 90 percent chance of a hike by December of this year. This is pretty significant.
Late July, before the last FOMC meeting, the market was priced at more than one full hike by September, and a total of about two and a half hikes into the middle of next year. So it's significant for repricing those expectations as well. The inflation data has kind of continued to be kind of improving, but also the economic growth data, especially the labor market, suggests some softening.
It's really not kind of a re-acceleration of growth. Now, the next risk event to watch that gets to alter this kind of outlook is on Friday, August the 28th, when Fed Chair Kevin Warsh will give a keynote speech at the Jackson Hole Central Bank Symposium. He may continue to be relatively opaque and not provide guidance, and not even indicate his kind of overall framework, which is the case for his first two appearances as Fed Chair during the press conference at the FOMC meeting.
But there was a report in the Financial Times about 10 days ago that suggested, and this might come from some insider of the Fed, that he's going to use that speech to explain his intellectual framework behind his sort of, what do you call it, kind of communications revolution, try to clarify what he believes is his own messaging shortfalls. So I think what the market is looking for is maybe some not guidance on what the Fed will do in September and beyond, but more of like, what is the framework or what are the reactionary functions that Warsh himself is actually using to form policy? At the moment, given what Warsh has said versus what he's done, the market sort of viewing it is ultimately he's willing to tolerate it, so maybe a high-pressure economy, run it a little bit hard, because ultimately he does seem to believe that over the long term, all this investing will be disinflationary, and he doesn't want to kind of cool the economy and bring that to a halt shortly.
So that's kind of what could transpire in roughly 10 days from now. That is a risk event. Ultimately, though, the data itself, we believe it's consistent with the Fed won't hike, and as we get the August data in a few weeks, if it comes in somewhere toward it's so high, I think those chances for September hike go even lower, and the window for the Fed to hike at all in any point in the near term starts to become smaller and smaller.
Now, Jason, I did mention towards the beginning that the market recently has been relatively calm. Now, you do discuss that in your latest blog, which is titled Holland Days. So can you speak a bit to the meaning behind the calmness in the markets we've been witnessing as of late, and what exactly do you mean by that title of your latest blog?
Well, just on the market itself, you know, we've seen equities and risk assets kind of grind higher throughout the month. Last week was a little slower paced, but it was still directionally positive. I think what is more noteworthy is that the relative calm point is that the VIX volatility index fell to 14.25 on Friday.
That's the lowest level it's been all year. It was a little lower right at the beginning of January, obviously rose back in March, but it's at the relatively low level. We've seen other volatility for individual stocks, like single stocks, also come down.
So what's driving this kind of low volatility? Well, part of it is the benign macro that I mentioned. Part of it is, you know, the market's not expecting, you know, maybe the Fed to hike in the way they did before.
Really good earnings. That certainly kind of boosted, you know, your confidence, as well as some of the guidance from these companies and how the monetizing AI can use this to support the idea that, you know, a lot of cap banks will get sort of compensated. Financing will still be available.
That stray can continue for a while. And then, you know, geopolitics, you know, has become a little bit of a back burner issue. You know, the situation with, you know, the conflict between the U.S. and Iran, you know, continues to simmer.
You know, cases escalate, but we're not seeing big moves in the price of oil. The oil prices are staying relatively contained. It does seem like any escalation can be relatively temporary, even if we're not getting to that ceasefire.
So if that is a form of gridlock between the U.S. and Iran, the market's allowed to, you know, take that. I think that's helping to kind of provide some calm. This is something I discussed in the blog in kind of more detail, along with what other points I've made on kind of the fad and growth.
The reason why I titled it All In Days, it's an echo back to 2023. And if you remember in 2023, the summer, that was the summer of Barbenheimer, you know, Oppenheimer and Barbie kind of, you know, combined into one. It was the summer of, you know, Taylor Swift and Beyonce, these sort of, you know, massive tours across the country, these big cultural events.
And there's sort of echoes to this year culturally to that, but also economically, I think, that are relevant. And if those parallels continue for the rest of the year, it perhaps suggests, you know, I think a relatively positive outlook for the rest of the year. Now, a couple of key things that happened in 2023 that sort of have echoes this year, you know, sort of history of Iran not necessarily repeating, is that, you know, at the beginning of 2023, the consensus expectations among economists is that ultimately the U.S. economy will probably go into recession, maybe a mild recession.
That didn't happen. You know, the U.S. economy grew 2.9% in 2023. And in the summer of 2023, while all that was going on, the cultural phenomenon stuff, the U.S. economy ultimately grew 4.7% in the third quarter of that year.
U.S. growth this year has been more kind of closer to what was expected to start, even though oil prices have gone higher. The real upside surprise has been on corporate earnings. They've been far exceeding what was expected at the beginning of the year.
That's kind of helped from a fundamental perspective, the outlook. The other thing that sort of parallels is the rise in interest rates. You know, the Fed was hiking rates for the first half of the year in 2023, culminating with one final 25 basis point hike in July of 23.
Then the Fed went on hold. As this happened, as the markets realized we're not going to get a recession, and the economy's quite strong, you saw yields go quite a bit higher. At some point from a peak, from a trough to peak, the 10-year treasury yields went up 150 basis points, ultimately peaking around 5%.
This year, we've seen sort of similar rise in rates from a higher base and not as high a peak, going up of about 50 basis points, you know, from the lowest back in March. Again, it's sort of expectations about a relatively strong economy, maybe some overheating that's persistent. The general thing about 2023 is that ultimately, that inflation didn't really materialize.
It started to come down, and the Fed ultimately pivoted and went on to an extended pause. That latter scenario, something that we think will play out as we discuss, the inflation data is likely to moderate, but it's likely to stay on hold. As market pricing then goes from pricing those hikes to not pricing maybe any hikes, maybe the next move is being cut.
We think that will provide a tailwind between now and year end, similar to what happened in 2023. So culturally, there's some echoes, but there's some interesting dynamics in terms of growth expectations, in this case, earnings foreseeing what was assumed at the start of the year, rates going higher, usually kind of sweeping the market, but ultimately kind of coming down. And we think that's similar dynamic that's likely to play out in the second half or the remainder of 2026.
Before we wrap up, let's conclude as we always do by providing our listeners with some investment recommendations. So as we're recording here on Monday, August 17th, what are your key messages for the balance of the summer and the rest of 2026? Well, before I get to that, I realized I didn't actually explain the Holland Days title.
Given the echo that I just alluded to in terms of 2023 of Barbenheimer, we don't have a similar mashup of movie titles, but we do have two movies that have dominated this summer, The Odyssey and Spider-Man. The common feature of that, Tom Holland, the actor. So instead of Barbenheimer, it's Holland Days this summer that that's the title.
So in case you were puzzling over that, Dan, I wanted to clarify. In terms of the key message, very near term, there's not a lot of key risk events. We get maybe the Jackson Hole speech from Kevin Walsh in 10 days.
NVIDIA reports earnings a couple days before that. Absent deadline information, relatively benign markets that are moving higher tend to continue to moving higher. Bigger pictures through year-end in 2027, the macro environment being relatively benign, supportive.
Deep learning stories, even more supportive. Just for perspective, at the beginning of this year, the bottom-up analyst consensus forecast for earnings growth for the S&P 100 in 2026 was about 13%. Now we're around 27% based on the earnings through Q2 and the guidance going forward.
And based on the guidance, we'd expect that earnings are going to grow about 20% in the second half of this year. After 2027, somewhere in the low to mid-teens. So very strong earnings growth.
And this is relatively broad-based. We've seen this in the earnings season, that it's not just a handful of tech companies that are driving things higher. The median company has had an earnings growth of around 12%.
We expect that earnings, that they're continually broadening out of the market. That's been going on. We've seen this with small caps outperforming for the past couple of months.
The equal weight that's in the S&P 100 indexes outperformed. EM equities outperformed. So we kind of lean into that, lean into more technical factors.
Still light tech, but just from a broadening perspective, that's something that can play out. In fixed income, we expect yields to decline as those market views on rate hikes for the Fed to dissipate. But where we have maybe more conviction as to where yields are going to go is more on the front end or the intermediate part of the curve, because that's very clear.
You can see as hikes get priced out, the two-year goes lower. And in fact, over the past month, the two-year treasury yield was about two basis points lower, whereas the 10-year treasury yield was about 15 basis points higher. That kind of favors us.
They're kind of shorter intermediate parts of the treasury curve or fixed income overall, avoiding long-end rates, because they could go higher if the economy is confused to run hot, or it turns out to run hot. And sticking with kind of higher quality fixed income overall. And finally, the decline in rates is one factor why gold has had a bit of a bounce in this month.
Gold is up about 8% to 9% from hovering around $4,000 for an extended period of time. As rate expectations go lower, as real rates go lower, the opportunity cost of owning gold declines. That's been one of the catalysts for gold to move higher.
We're also seeing some investors, particularly institutional investors like central banks, like the Central Bank of China, have been buying gold. And so now you're seeing investors who didn't really want to touch the metal for a period of time with a lot of volatility, kind of look at this as a kind of maybe a floor in. There's some technical buying rates are going to go lower.
That's a support for gold. Ultimately, we think it is a better than medium-term portfolio diversifier, hedging against the possibility that warship and the Fed do let the economy kind of run hot. There's questions about the fiscal situation in the U.S. kind of persist.
There's concerns about the dollar kind of persist. Gold becomes sort of a medium-term hedge on that. We see a good upside over the next 10 months for gold.
Near-term, given we're already materializing, it probably won't be until we actually clearly see the Fed's, you know, kind of hiking expectations go even lower. They're kind of priced out. That would be another catalyst for gold to go higher.
But ultimately, I think it's that attractive to first find this macro environment overall. Well, Jason, as always, these conversations to begin a new trading week, always very helpful. So thank you for dropping by again on this Monday morning to keep our listeners informed as to what's driving markets and how to be positioned accordingly.
And do look forward to picking back up with our conversation again here soon. You're welcome. Transcribed by https://otter.ai Transcribed by https://otter.ai
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