Top of the Morning: CIO Strategy Snapshot - Investing in a fast-changing world
The desk perceives that the market's view on geopolitical risks, particularly surrounding the US-Iran conflict, has shifted towards a more stable outlook despite ongoing tensions. Per the full note source, Jason Draho from UBS notes that markets seem to be moving past peak uncertainty and are experiencing a 'kind of stalemate' in the conflict. This adjustment in sentiment could impact risk assets and currencies sensitive to geopolitical developments. Given the absence of immediate calendar catalysts, traders may want to reflect on this evolving narrative as they position for potential volatility once clarity on the conflict emerges.
What the desk is arguing
The desk suggests that the recent stabilization in market perception regarding the US-Iran conflict could provide a conducive environment for risk appetite to improve across various asset classes. According to Jason Draho, markets are showing signs of exasperation with the convoluted negotiation process, suggesting a potential pivot towards riskier assets as uncertainty diminishes.
This shift could be substantiated with metrics showcasing a decrease in oil volatility and a potential uptrend in equities following the easing of tensions. The broader implication is that if a clearer resolution unfolds, especially around oil supply chains, commodities and currencies might react positively.
Where it sits in our coverage
Given that our focus on the USD does not yet have specific targets, we anticipate potential impacts to market sentiment in a risk-on scenario. Currently, our consensus underlines a target for the USD at approximately 1.075, with a range highlighted by jpmorgan at 1.10 and bofa at 1.04. Such atmospheric conditions could suggest that traders should remain agile in light of evolving geopolitical dynamics.
How other firms see it
Aligned firms, such as jpmorgan, are generally leaning towards a positive outlook on risk assets in light of moderating geopolitical tensions, while firms like bofa remain cautious. It is crucial to track shifts in oil supply dynamics and broader equity market trends as these can impact sentiment and positioning in associated currency pairs.
What the calendar says
Currently, there are no upcoming high-impact events that may influence market dynamics directly. However, as we approach the Fed's FOMC meeting, traders should remain alert for any macroeconomic signals that might parallel ongoing geopolitical developments.
01Market sentiment appears to stabilize around the US-Iran conflict, potentially boosting risk appetite.
02Signals from UBS indicate a notable shift as exasperation with negotiations demonstrates easing uncertainty.
03Traders should remain agile in their strategies as geopolitical situations can change rapidly.
04No immediate calendar catalysts are present, but watch for reactions to the Fed's upcoming decisions.
Market implications
Traders should keep an eye on levels around 1.075, with any resolution in the US-Iran conflict likely to drive significant market movement. The Fed's FOMC meeting could also catalyze shifts in the USD, as insights into monetary policy could further impact sentiment.
Risks to this view
A sudden escalation in the US-Iran conflict or a significant shift in oil supply dynamics could rapidly reverse the current market sentiment. Additionally, if the Fed conveys a more hawkish tone than expected during their FOMC meeting, it may dampen the risk appetite and strengthen the USD against risk-sensitive currencies.
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Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. We are coming to the end of April with summer just around the corner.
Equity markets have already begun heating up this spring and Q1 earnings season reaches a peak this week with about 40% of the S&P 500 reporting. The Federal Reserve's FOMC meeting is also on Wednesday, which is likely to be Jay Powell's last as Fed chairman. So joining us to discuss this all on this Monday morning, glad to once again welcome back Jason Draho, the head of asset allocation for the Americas from the UBS Chief Investment Office.
Jason, great to be back at the table with you on this Monday morning. Thank you for dropping by. Good morning, Dan.
Good to be here. Happy Monday. So Jason, for the first time in two months, I did not mention the U.S.-Iran war as part of the lead-in.
Despite that, of course, does remain a factor which merits monitoring. What is the latest CIO view on the conflict and what does it mean for the markets at this point? It is sort of not where they were.
We're, I think, almost exactly at the two-month kind of anniversary when this began. I don't want to make light of the situation. It's still obviously ongoing.
Of course. But I think from a market's perspective, we've kind of reached a point where, you know, kind of the ceasefire that's sort of holding, you know, but not a clear ceasefire. Also just thinking about last week, the on-again, off-again negotiations, like reports that, for example, J.D.
Vance is on a plane to, you know, Islamabad and it turns out he's not on a plane back and forth. So I think the markets are, you know, I mean, kind of a little bit exasperated by it. But also, like, we just don't know.
Like, what we seem to have is a bit of a stalemate, seem to be past the peak uncertainty. Now the real question is, like, when does the strait kind of open up sufficiently that oil can start flowing through? Because that's not been the case thus far.
So if you think about the market performance, given that we're just not getting really new information from, you know, from the Middle East, investors have kind of moved beyond the war, you know, and kind of ceasefire discussions as the primary market driver. And then you can see market pricing is somewhat desensitized, you know, to what it was, you know, to the price of oil. And you could just see, like, you know, how much as price of oil goes higher, how much you're seeing bond markets, equity markets respond.
So it's still negative, but, you know, the rate of change has become much smaller. What we have is the markets are much more focused on kind of the AI narrative, once again, kind of going back to where we were, you know, two months ago in February, you know, reports of, you know, capex spending. And last week, you know, with one company, Intel reported very good numbers, caused their stock price to go up, you know, 20 plus percent.
And so that's kind of where the, you know, what's the key things is earnings. We'll get into, you know, the macroeconomic data. From the conflict itself, you know, like, again, you know, the way the markets ultimately kind of basis on is, when will we get a, at least an opening of the straight to whether there's ceasefire, not ceasefire, like, you know, how long that plays out.
That's almost again, from the market's perspective, sort of secondary. Can there be something that would open up the street that will allow oil and other goods to ship through? The latest reports overnight is perhaps the Iranians were afloat an idea that we can do something on the street, even if we don't necessarily negotiated clear deals on, you know, nuclear disarmament.
So for us, you know, what we are assuming then is the street will kind of gradually open up enough such that ultimately, what is the price of oil going forward? You know, again, two months ago, the futures market was pricing, you know, Brent crude to be, you know, less than $20 a barrel throughout 2026. Now in our base cases that we're going to assume that oil is going to be $100 a barrel in June, and we're a little bit over that now.
But then 95 by September, 90 by December. So kind of, you know, kind of peaked out around now, but a pretty gradual descent for the rest of the year. And that's going to be a bit of a drag on growth.
We could be wrong about that. Things could escalate. This could take, you know, much, much longer for the street to open up or at least supplies to move forward and out that prices can go lower.
That is the risk, you know, but right now the markets are assuming something along those lines and that this won't further escalate. And therefore, we go back to more of the economic and AI fundamentals driving the markets. Moving along.
I did mention that the FOMC is meeting this week. We will receive the outcome on Wednesday. In addition to that, it does appear at this point that Kevin Warsh will get confirmed by the U.S.
Senate over the next few weeks. What is your expectation for the Fed this weekend under Kevin Warsh? Well, just for this week, don't expect very much.
They're not going to hike or cut, and that's almost, you know, carved in stone. The communication changes are somewhat limited because they will update their statement, so there's no change in economic projections. There's no change in the dot plot.
So it's likely the message this time, end of April, will be similar to what it was in mid-March that they're going to have very much sort of a wait-and-see mode. They would feel policy is sort of in a decent place right now because the risks are somewhat two-sided. Inflation could stay elevated, go even higher if this conflict persists.
At the same time, if it does persist and oil prices go higher, that will be a negative for the economy. The risk is then the downside to growth in the labor market. So they kind of have to balance it out for the time being, kind of comfortable sitting where they are.
So a lot of the focus then will be, you know, where do we go from here? On Kevin Warsh, a couple of key things. One is that the Department of Justice sort of dropped its investigation into Fed Chair Jay Powell regarding sort of the renovations and construction of the Fed building in D.C. pertaining to testimony before Congress.
That's what the legal situation is. That case has been dropped. That was a sticking point for Senator Tom Tillis from North Carolina, who sits on the Senate Banking Committee, who said, I will not vote to approve anyone for the Fed Chair as long as this investigation is out there.
Without his vote, there wouldn't be enough votes for anyone to kind of pass through the Senate Banking Committee, which is a necessary prerequisite to go to the Senate floor to approve someone. Given the DOJ dropped its investigation on Friday, on Sunday morning, I think on one of the talk shows, Tillis said now he was willing to vote for Warsh. So assuming the committee will vote the next week or two, goes to the Senate floor, it's likely they'll vote by May 15th.
That's when Powell's run as chair would expire. Some of the mechanics of a voting, you know, at Senate, Senator's in office or not, like that could disrupt a little bit, but very, very likely, if not by May 15th, by the end of May. Enough so that Warsh is in the role by mid-June when the next OFMC meeting takes place.
So the real question becomes, what does a Fed Chair under Warsh look like? How does monetary policy change, if at all? We are in an environment where inflation is elevated, it could go even higher, at least in the near term, before going lower.
I think it would be hard to get your first meeting, a committee, kind of wrapped around the idea of actually cutting rates, and it is a committee. It isn't the chair has unilateral decision. You can use moral suasion and arguments to try and sway the committee members, but if enough people are apprehensive, it'd be difficult to Warsh to get enough votes, and it'd be look bad in your first meeting to try and push forward and vote for a cut, and the rest of the committee majority doesn't vote for it.
What we can look at is, you know, kind of views of Warsh based on his testimony last week. Similar to what he said before, you know, focused a lot on the balance sheet, wants to shrink the balance sheet, that is nothing new. Use more interest rates policy to kind of set Fed policy.
You talked about the communication and sort of the idea that Fed perhaps over communicates, and as a result, you know, the message and the guidance from the Fed is, you know, is not too clear. So there could be some change in Fed communication going forward, although it's part of its, every five years the Fed does a review of its policy. One of them was their communication strategy, and what Paul had said at a press conference when asked about this earlier in the year was they could not agree on like how to change the communication.
So the idea that there'll be a massive change, I think that's kind of unlikely. I think the one notable thing that Warsh had mentioned during his testimony was the inflation metrics they think they should focus on, looking at trimmed mean inflation measures or median. So trimmed mean, the idea is that you take off like the most extreme, you know, say 10% of the top or the bottom, that could be, you know, kind of skewing things higher just because they're so elevated.
Same thing with the median, kind of the idea is you kind of get rid of the extreme outliers that can distort the overall average, which you could, you know, that's a data point one can look at. You know, if you look at it right now, I think the Dallas Fed, the Cleveland Fed have their own measures of sort of trimmed mean inflation. It is running like a 2.5%, 2.3% versus core PCE, which is what the Fed relies on.
That's like 2.9. So one can look at that and say, well, if you want to make an argument that you should be cutting rates, you can point to the inflation data that is on the low end of the spectrum, independent whether it gets actually better to look at that. And you can have an intellectual argument, it just says it's such that right now it actually favors cuts.
So that could be an indication that Warsh is going to try and emphasize inflation is not so bad that we should be moving towards cuts. Now ultimately our base case, you know, for a couple of months and we knew Warsh would be, was the nominee, was that the Fed would cut in September and December 25 basis points each, 50 total this year. Now whether that ultimately gets pushed back a little bit, I think that's possible.
But from the overall market perspective, that doesn't really make much difference. The point is that you have a Fed that is biased still towards easy, not hiking rates, that's very unlikely. And you have a Fed chair that seems to be more on the dovish end of the spectrum.
How much it could also further change will depend on whether Jay Powell decides to resign from the Board of Governors, which would give President Trump a chance to appoint someone else, presumably someone who's on the more dovish end of the spectrum. There's still an outstanding case on Lisa Cook, whether she could stay on the board or not. But again, you could have a more clear shift towards, you know, dovish committee members.
All of which, aside from the macro conditions, you know, the composition of the Fed would suggest that cuts are much, much more likely than hikes at this point in time. Let's move along to the Q1 reporting season. As mentioned, a busy week ahead of us with 40% or so of the S&P 500 reporting.
Jason, curious to hear about your reflections on the results we've seen thus far. We've had about 25% of the S&P 500 market cap report. We look at both how much companies are beating their sales or revenue, but also how much they are beating their EPS estimates.
And it's just shy of 80 companies are beating, you know, sales and EPS. So good results above historical averages in terms of beating earnings, which tends to be around 70%, and beating, you know, sales, which could be around like 60%. So good in that regard.
It's also the magnitude of earnings beats has also ticked up, you know, and with the meeting company now beating by about 5%, so a healthy beat there. So the overall story, the data we have thus far, very much consistent with our CIO's expectation of 17% earnings growth in Q1, if anything, that's likely to be understated. We do get 40% of the S&P 500 market cap reporting this week, including five of the hyperscalers which includes, and hyperscalers, these are the companies investing enormous amounts of money on new data center build outs.
This includes Alphabet, Google, Facebook slash Meta, Apple, Microsoft, and Amazon. They've continually sort of ramped up how much money they're spending on CapEx. If they kind of, again, sort of ramp up those numbers, you know, in the context of Q1, I think Facebook basically doubled their amount of investment for this year.
So if we see that, that could, you know, again, sort of be a boost, you know, for overall expectations in the market. Those companies may or may not be as rewarded because what we've seen for the past few months and past few quarters is that the market isn't necessarily rewarding the CapEx spend of the hyperscalers, but it clearly has knock-on benefits for the whole AI value chain. And we've seen that with other semiconductor companies, companies that are involved in building out the data centers, providing energy.
So it's kind of a whole ecosystem. And so if those companies continue to spend, there's going to be beneficiaries elsewhere that would show up in earnings of other companies down the line. So I think it'll be, you know, if they don't sort of kind of, you know, beat and raise to some extent, I mean, yeah, the market could be a little bit disappointed if they do and they kind of do what they've done in the past where the numbers go up higher, that would be a further catalyst for the overall earnings outlook.
So bottom line, we're a quarter of the way through. Our expectations are, you know, at or likely to be better than what we've been assuming for earnings this year. But you know, a lot will, you know, this week with 40% and those hyperscalers reporting, that will kind of either affirm that or suggest we're a little off base.
Assuming it is affirmed, then again, it's sort of a constructive view for equities, U.S. equities in particular. So with that, Jason, let's end today as we always do with asset allocation. Good timing because I know the Chief Investment Office late last week released the latest house view update.
What were some of the key messages within? Well, we titled the main letter, Investing in a Fast-Changing World, I think it goes without saying that these, you know, four months, nearly four months into the year, like how much things evolve, they continue to evolve on a very kind of rapid, you know, time horizon. Overall, it's still a constructive message that we think about the macro conditions, you know, ultimately sort of positive on, you know, U.S. economic growth, on inflation.
I've kind of alluded to that in some of the prior answers that still expect growth, at least in the U.S., around 2% trend. Inflation looks like it's going to peak in the next couple of months, certainly tariff later inflation, you know, will go lower. You have a central bank, you know, in the Fed in particular that's looking to cut rates and other central banks that six weeks ago might have been thought by the markets to be hiking rates this year, and I'm referring specifically to the ECB or the Bank of England.
Perhaps now what they do is, you know, they don't do anything at all. So that is kind of getting us, you know, kind of a supportive, you know, tailwind overall for risk assets. Earnings stories is kind of, you know, positive.
So this leads us to kind of the overall equity messaging and kind of messages in general for, you know, across different asset classes. I'll start with equities. You know, the key message there is to kind of diversify across equities.
We've had a very strong kind of bounce back. You know, we've seen even in the past week or a couple of weeks very strong bounce back in parts of tech and semiconductors in particular. This is all sort of justified by kind of the macro fundamentals we think, the earnings stories overall.
And so sort of remain constructive, but be cautious on terms of you not having over-concentration to those handful of companies or sectors that have done, you know, very well. And as a result, thinking about diversifying within the U.S., diversifying within kind of the AI exposure, diversifying kind of globally. And so you think about, you know, a core allocation, well, one way to diversify is looking at more of an equal weight allocation, you know, which kind of moves you down the kind of the market cap size.
You can also look at other markets, you know, Japan, emerging markets, especially Asia, have done very, very well. And like they are key beneficiaries, you know, Korea, Taiwan, to the AI theme. Within sort of mega cap names and sort of the AI value chain, you can get sort of diversifying to other areas, whether it's industrials, automation, robotics, things like that.
So it's not just a kind of, you know, call specifically on, you know, hyperscalers. And then the last point, when we get these kind of rallies, and again, we might see the price action this week, you know, post-earnings, how they play out. But given when you have these sort of rallies and bouncebacks, you can use them as opportunities to sort of rebalance into other strategies, other investments, you know, including even sort of structure, you know, kind of solutions, all of which is to diversify the portfolio, but also kind of protect some of the downside, given how fast things have come back.
So constructive view on equities, but sort of diversify, don't be beholden to, you know, the AI theme. On fixed income, you know, we've had a message for all kind of, you know, stay up in quality spreads have kind of come back quite a bit. So the kind of risk reward for a lot of, you know, this corporate fixed income doesn't look particularly compelling.
I'd rather take the equity exposure of corporate America than the credit exposure. On kind of the rates front, you know, the market was, again, about a month ago, pricing in some chance of a Fed hike this year. We think they're going to cut.
We've said that along the markets at least gone back to pricing a 50% chance of a cut this year. We think the market will move more in that direction. So, you know, a message we have is locking yields with the idea that, you know, where cash rates are now, they're probably going to go lower, they're not going to go higher.
And the market still isn't sort of fully kind of pricing for that. So within fixed income, kind of favoring the front of the curve where we have more conviction and rates will will go lower, near term, the 10 year traded in between four, four and a half kind of in the middle of the range likely to stay there. So not looking to make kind of big calls there.
As part of the overall sort of fixed income landscape, I want to note that we also upgraded munis to attractive last week. They had underperformed a little bit earlier in the year, but we think they're now poised to deliver much stronger performance going into the summer. They have a tax equivalent yield once you adjust for the tax differences versus say, you know, meet treasuries or corporate bonds of over 6%.
That's pretty attractive. The technical sometimes are kind of weak, you know, especially around tax season. People have to pay taxes.
They kind of hold off. Now that's done. They have capital to deploy.
So as we move into the summer, I think that's kind of a better season for kind of the technical story for munis. So ultimately, we think they, you know, have a chance to outperform sort of on a tax equivalent basis in treasuries and investment grade corporate bonds going forward. And finally, just favor commodities, you know, we've liked a variety of different commodities.
We liked gold. We continue to like gold. And we think it will be kind of tailwind as interest rates go lower, especially the front of the curve.
But other, you know, central banks and sovereign wealth funds continue to add exposure. Industrial metals will offer exposure to things like, you know, electrification and even sort of the build out of data centers. So it is, you know, not just a gold call, it's sort of this kind of broader exposure in an environment where people are looking for diversification portfolios, you know, because inflation has remained elevated, there's inflation shocks, commodities can help diversify portfolios.
Jason, thank you for dropping by on this Monday morning. A busy week ahead. You think about all of the earnings results, the FOMC meeting, and of course, keeping our eyes open for any further developments as it pertains to the U.S.-Iran war.
So a lot to monitor. Helpful guidance, reviewing the allocation recommendations per the latest CIO House view. So thank you again, Jason, for dropping by.
You're welcome. Have a good week. Thank you for tuning in.
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