Top of the Morning: CIO Strategy Snapshot - Jackson Hole takeaways
The desk argues that the recent discourse from the Jackson Hole Symposium, particularly Fed Chair Powell's remarks, indicates a nuanced path for future monetary policy, influencing market sentiment significantly. Per the full note from UBS, Powell's speech echoed a more cautious stance, suggesting that while the FOMC may maintain interest rates in the near term, any future hikes will be data-dependent, a position seen as potentially bullish for risk assets. This framework could also affect USD positioning, as traders assess market responses and adjust expectations according to Powell's guidance on inflation and employment metrics.
What the desk is arguing
The desk perceives Powell's comments as a key signal indicating that the Federal Reserve may remain on hold longer than previously anticipated, given the current economic indicators. This dovish tilt could lead to a recalibration of interest rate expectations across various asset classes, heavily influencing FX strategies.
Supporting this view, Powell emphasized the importance of upcoming economic data, especially inflation metrics, as critical inputs for determining the pace of future rate adjustments. He noted that keeping inflation expectations anchored remains a priority, suggesting vigilance in monitoring market reactions to policy changes.
Where it sits in our coverage
Currently, our consensus target for the USD/EUR pair is 1.075, reflecting a slight bullish sentiment on the dollar against the euro for the March 2026 tenor. Notable projections include: - jpmorgan: 1.10 - bofa: 1.04
This perspective aligns with consensus, indicating a slight skepticism among certain market players, with bofa projecting a more bearish outlook on the dollar's strength.
How other firms see it
A cluster of firms is suggesting similar bullish positioning for the USD, reflecting confidence that the economic backdrop will support a stronger dollar. In contrast, bofa presents a contrary outlook, predicting weaker performance for the dollar amidst a more aggressive rate cut environment.
Market dynamics around the Fed's upcoming meetings and employment data prints will be crucial to monitor, particularly how they inform traders on USD positioning against pairs like the EUR/USD or AUD/USD.
01Powell's tone suggests a cautious outlook for future rate hikes, impacting FX positioning.
02Market responses indicate volatility as traders adjust to new rate expectations.
03The consensus for USD/EUR remains mildly bullish, but there are differing views among firms.
04Upcoming economic data will play a crucial role in shaping monetary policy discourse.
Market implications
Watch for the USD/EUR to breach the 1.08 level as market sentiment shifts in response to Powell's guidance and economic data releases. Any strong prints on inflation or employment could catalyze a stronger dollar rally.
Risks to this view
A reversal could be prompted by unexpected labor market weakness or a significant inflation slowdown, which may lead the Fed to reconsider its stance and potentially implement rate cuts, adversely affecting USD strength.
ubs
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
The financial markets continued their climb higher last week, supported by Fed Chair Jay Powell's comments at the Jackson Hole Central Bank Symposium. Investors get a final week of summer before the Labor Day long weekend, but it's unlikely to be too quiet with Nvidia reporting earnings on Wednesday, the 27th. So joining us today for the CIO Strategy Snapshot.
Glad to welcome back Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office. Jason, thank you for stopping by. Probably our final summer conversation for 2025.
Great to have you back here in studio. Thank you, Dan. It's good to be here.
I guess this is more the unofficial final because we will do some before September 21st. But no white after Labor Day, as they say. Yeah, the rules are meant to be broken.
Exactly. So Jason, the big news last week, let's begin with this, was, of course, Fed Chairman Powell's speech, which went down well with investors. We did see a nice market response on Friday.
What exactly did he say that investors liked? Well, I can give you a few kind of quotes, like literally what he said, because it was in the speech was released. You know, first he said that, you know, the baseline outlook and shifting balance of risks may warrant adjusting our policy stance and that they will proceed carefully as we consider changes to our policy stance.
Now, if you kind of listen really closely in the first sentence, I said, you know, the word may warrant adjusting our policy stance. So investors heard adjusting our policy stance is a signal that the Fed's going to cut rates in September. I'd say may is probably important.
It's doing a lot of heavy lifting, as it were. But that's kind of basically what the market's viewed as. It was a dovish pivot by Powell.
He didn't definitively say it, but, you know, the way a lot of people would interpret it is that's about as close as a Fed chairman will get towards saying there'll be cuts. I think that's a debate about nuance and subtlety, but that's how the market's kind of took all this. I mean, Powell said a few other things I think that are relevant to mention.
One is that he noted that the labor market was in, and this is a quote, a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. And that labor supply has softened in line with demand. So this is one of the issues with assessing the state of the economy as an investor, but also certainly if you're a J Powell or a member of the FOMC, that's sets policy rates.
That is, you look at some labor market data, the monthly job growth has declined. So the three month average now based off the July data is down to 35,000. Prior to the July data that we got in early August.
So the data the Fed would have had before that meeting, it was at 150,000. So big step down as due to revisions and a slower payroll report. That would seem sort of, you know, we're worrying.
But then if you look at the weekly initial jobless claims, they are still at a relatively low level, like nothing relative to the past year that would indicate, you know, it's ticking upwards and sort of rising. It's certainly not pre recessionary in the way that 35,000 jobs a month looks kind of pre recessionary levels. So some of that, again, reflects the fact that hiring is slowing, but also firing is slowing.
Immigration is much less so the supply of workers is much less. But this is, you know, this is a kind of the one of the challenges for the Fed and for investors trying to get a sense of what's really going on in the labor market. The fact that he mentioned that sort of implies that they're between their dual mandate of price stability and full employment, they are perhaps shifting a little more weight to full employment.
And that's echoed by the fact that, you know, Powell also said that there's a reasonable base case that tariffs could result in a one time shift in the price level, ie, you know, prices will go up, but a year from now, we'll see inflation coming down, you know, quite quickly. So all this is sort of why the markets interpret this kind of as a relatively dovish commentary. Something I just all mentioned, but it wasn't why the markets rally so strongly on on Friday was that every five years, the Fed, you know, reviews, it's kind of long run goals and monetary policy strategy.
Five years ago, that review led to the implementation of flexible average inflation targeting. The point being is that the Fed would be a little bit slower to tighten policy because they'd want to see inflation above 2% for a period of time. Because basically, for an entire decade, it was below 2%.
And so to balance it out, you will need to be above not great timing, in hindsight, given the inflation surge during the pandemic and post pandemic period. This strategy review resulted in basically dropping average. So it's still kind of flexible inflation targeting, it's still a 2% target they're going to focus on.
You know, the committee will did remove some language, you know, in terms of the only respond to shortfalls for maximum employment, if the overshoot sort of maximum employment, which by definition sort of sounds like how do you actually shoot overshoot maximum, but, you know, for them would be a 4% is sort of their sort of neutral rate of unemployment, if you get down to 3.2%, where they would not ignore that they might actually have to sort of tighten policy. So not a major change from what they're actually doing right now. And ultimately, given there will be a new Fed chair effective next, you know, kind of by June, other Fed committee members could also change that that period of time.
The way the Fed approaches monetary policy is probably going to shift more for that versus this strategy review. If you have more diverse people, there could be changing communication. But if we just sort of bring it back, ultimately, what the investors were most looking for last Friday was, will the Fed cuts, you know, in September and Powell kind of basically said, we are definitely preparing for that.
So I think the bar is relatively high for them not to cut at this point in time. So Jason has CIOs outlook for Fed policy in the near to medium term has that at all changed based on what we heard from the chairman on Friday, we're going into Jackson Hole, our official view was the Fed is going to cut in September 25 basis points. And we'll cut it every meeting until the q1 the January meeting q1 of next year, for a total of 100 basis points of cuts.
So but that, you know, did not change our thinking the palace speeches that have kind of reinforced the view that yes, September is quite likely, just for for numbers, prior to palace speech. So as of Thursday, the market was pricing a little over 70% chance of a cut in September. After it by the close of Friday was up to 85% chance.
So not a done deal, because we will get one more month of data, we could see a jobs report that's better than expected. And those prior down revisions could be reversed, they could be revised higher, that three month moving average could go back up to 100,000. That's very possible, which it's a little bit harder for the Fed to cut in that situation.
Likewise, inflation could be harder than expected. The market pricing for you know, the cuts this year still around 2.1% by December, and pulled forward a little bit at a time and when they get to four cuts by next year on next April versus March or versus June. So we're I'd say our expectations are a little more aggressive.
The general thinking is that if the Fed believes even with inflation going higher, in the short term, if the labor market is cooling enough, if they believe policy is restrictive, once you start cutting, it would make sense to kind of get policy to more neutral stance to avoid further downside risks. That we'll we'll see, we'll see what the the data actually brings. And of course, then in when they make that announcement in September, assuming they cut, they also update their economic projections, and we'll get a further clarity of like, is this will this continue or not.
So focusing on market pricing for a few moments, Jason, the S&P 500 has been on a pretty relentless climb higher for over four months and throughout the summer with only minor speed bumps. But that's not the only story in markets. What else do you see happening at the moment?
Well, if you would just look at certainly last week and the way the markets in the last week, but it kind of reflects performance really over the whole month leading up to last Friday, that it's been a bit of a rotation within the S&P 500. Small cap stocks have outperformed large caps. Last week, just alone, the Russell 2000 index outperformed the S&P 500 by three percentage points.
It outperformed the Nasdaq 100 by four percentage points. Cyclical sectors outperformed, values been outperforming. So definitely kind of a cyclical value, higher beta, you know, your rotation equity market performance.
Another thing that's been getting a lot of discussion in the marketplace as the S&P just continues to grind higher, set all-time new highs, valuations are getting elevated near the top end of the range where they've been for the past five years. Your concerns about bubbles, that's definitely kind of risen as a risk. If I look across the markets, equity markets specifically, there are some pockets here and there.
You could say this looks a little frothy. You know, we've seen some IPOs go public and their share prices double, triple within the first day or within a couple of weeks. Mean stocks, some of that activity has kind of come back.
But it's really not kind of widespread. We haven't seen things kind of like, you know, that exhibit real kind of exuberance or rationality that you typically associate with a bubble. Other measures, like just literally investor sentiment measures, like the, you know, AAII kind of bulls minus bears, that's actually, you know, not elevated at all.
Investor flows into ETFs, you know, kind of average, a little bit above average, but not extreme. It's not as if money is, you know, on across the board is plowing into, you know, equities. But, you know, had a good run, things are elevated.
Another, I think, observation worth pointing out is that if you look across corporate credit, spreads, you know, are tight. Investment grade corporate bond spreads reached a 25 year tight. So, well, you know, if you say equities are expensive, I think the credit markets and credit investors might say, hold my beer, because I'll show you some evidence that we're on a percentile basis, credit spreads are even tighter, which is one of the reasons why we'll come to position, but, you know, we're kind of a little cautious on taking too much risk there.
Looking also at the market performance on Friday in particular, equities went up, cyclical equities went up, credit spreads went lower, but we saw interest rates go lower because the market was pricing in, you know, a more aggressive Fed cuts. But that was true kind of across the curve. The two year, the most sensitive to a Fed cut, that went down, you know, 10 basis points, but even the 10 year was down seven or eight basis points.
The dollar also weakened. I say all this because in a reflation trade where the markets are expecting higher growth, higher inflation, you know, support or perhaps by policy, you see the equity performance that I summarized, but you'd also see rates go higher, you'd see the US dollar go higher. So in some ways, the market's pricing was actually, you know, everything rallies, bonds rally, equities rally, the dollar doesn't, but because, you know, emerging markets or other markets around the world kind of rally, that's almost more aligned to a kind of a Goldilocks type of situation.
So that's kind of where the markets have been, I'd say, for the past, you know, month or so and even a few months of toggling between sort of a reflation kind of Goldilocks. And by Goldilocks, I mean, growth kind of holding up better than expected, inflation not being as bad as expected, not fantastic conditions. We know growth is slowing, inflation is going higher, but relative to expectations, better than feared versus what people, investors assumed back in April.
So Jason, before we close out, let's, of course, spend a few moments on asset allocation. Timing is great, because the house view was updated last week. Can you walk our listeners, our clients through the main changes to CIO's recommendations at this time?
So the recommendations should be viewed in the context of the market performance I just alluded to in terms of how well equities have done, how well credit has done. It also takes into account our views on the Fed cutting rates, but also like the idea that, you know, the economic backdrop is, you know, we'll get a little bit worse before it gets better, but ultimately still, you know, 12 months out, we still feel comfortable about, you know, recession is unlikely, growth probably starts to pick up as we move into next year, inflation starts to come down. So that really would be a kind of Goldilocks growth accelerating, inflation coming down, Fed cutting rates.
That's a conducive environment for equities. Equities are already pricing a lot of this kind of good news in how much they've rallied, their valuations are elevated. We updated our earnings forecast for the S&P of 100 for this year and for 2026.
We now expect earnings per share this year of 80% growth. That was the assumption at the start of the year that went close to zero back in April. But earnings have just been, you know, solid expectations.
So kind of back on track. And likewise for next year, but seven and a half percent growth of earnings. That's the key driver for why we see equities going higher.
So we upgraded our price target for the S&P 500 to year end to 65 from 62. Again, this is close to where we were at the beginning of this year. And then up to 6,800 by June of next year.
Again, largely driven by earnings growth, not a lot of valuation expansion, but the fundamental story is kind of relatively strong. So bull market continues. Unlike early in the summer where we saw a lot of risk events, those risk events have been sort of melting away perhaps in the summer heat.
And so now the message would be, you know, look for dips and sort of pullbacks as opportunities to kind of selectively add exposure in some different areas, including continuing on kind of the AI theme on sort of tech, you know, kind of power and resources, some of the more secular themes in the marketplace, financials, value stock that's do well, they also have sort of a regulatory or deregulatory kind of tailwind. Back to fixed income, you know, the Fed is now likely to cut rates, or even more convinced the Fed will cut rates. So if you've been sitting on the sidelines, those, you know, money market rates are going to keep kind of going lower and lower.
So put that cash to work. Going back to my point about credit spreads and credit being rich. That's why we kind of stay up in quality, we don't think you're getting compensated for taking the credit risk.
If there's more upside, you're better off getting equities. So don't take a lot of duration risks to up in quality. Something that we like have liked for a while that's hasn't necessarily done poorly, but also outperformed is mortgage backed securities.
We're seeing now they're spreads relative to investment grade corporate bonds are tightening. As investors look for more yield, they're trading rich to this. And these are basically quasi government guaranteed securities.
So if you're getting more compensation for these securities versus investment grade, without taking more risk, that seems like it's a kind of a, you know, an obvious thing to do. So that's something else that we like. And then, I think last week, I already alluded to on this podcast of upgrading our price targets for gold.
So you know, kind of more upside in gold, it's been a good diversifier, we think there's both pure performance, but also diversification benefits for having a sizable or decent allocation to gold in your portfolio as well. Well, Jason, helpful touch base, as always, thank you for dropping by spending some time with our listeners and clients to provide some takeaways from the Jackson Hole Symposium was very market moving last week. And for walking us through the latest asset allocation recommendations from the chief investment office, I will point out to our listeners and clients, please reach out to your UBS financial advisor, if you would like to receive a copy of the latest UBS house view directly can also now be located up on UBS.com forward slash CIO, Jason, I think we'll be back here in a few weeks, respective vacations coming up.
So have that to look forward to but looking forward to getting back on the mic with you in September. Yeah, we're entering summer on a good note, hopefully for the markets and for for the weather as well. Definitely.
Thank you, Jason. Speak soon. You're welcome.
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