Top of the Morning: CIO Strategy Snapshot - Just get on with it already
The desk emphasizes that the current macroeconomic environment, influenced by rising inflation and changes in labor market dynamics, is creating pivotal conditions for currency traders. Per the full note , August's robust payroll figures and inflation data suggest that the U.S. economy remains in a relatively stable, albeit precarious, state. This sentiment is further complicated by the imminent Federal Reserve meeting, which is poised to address these developments and potentially signal future monetary policy shifts. Traders should prepare for increased volatility, particularly in response to U.S. economic indicators and Fed commentary.
What the desk is arguing
The desk posits that heightened inflation concerns and positive payroll numbers signal a cautious optimism around U.S. economic stability, suggesting traders should position themselves accordingly. Looking at the data, August's core CPI increased by a surprising 0.3%, indicating persistent inflationary pressures that will likely be addressed at the upcoming Fed meeting set for later in the week.
As the Fed prepares to react to these economic inputs, traders should focus on how monetary policy may evolve in light of recent conditions. The crucial takeaway here is that the ability to navigate these macroeconomic signals may define successful trading strategies for the remainder of the year.
Where it sits in our coverage
Our consensus forecast for the USD/EUR stands at 1.075, anchored within a range of 1.04 to 1.12. Specific targets from notable firms include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk's thesis appears to lean towards the higher end of current forecasts, aligning it with jpmorgan while contrasting the more conservative stance of bofa.
How other firms see it
Firms like jpmorgan and goldman share a similar perspective on the need for traders to respond proactively to inflationary trends, indicating a general alignment on potential USD strength. In contrast, bofa maintains a more cautious outlook on the U.S. economy's trajectory, reflecting concerns over sustainability.
Traders should monitor key indicators like U.S. CPI and Fed movements for emerging trends, particularly in the EUR/USD and USD/JPY pairs, as these are intricately linked to the overall U.S. economic narrative.
01Rising inflation and robust payroll data indicate a cautiously optimistic U.S. economic outlook.
02The upcoming Fed meeting will be crucial in determining the future direction of monetary policy.
03Traders should anticipate increased volatility in response to economic indicators and central bank commentary.
Market implications
Expect market volatility ahead of the Fed meeting, particularly as traders react to inflation data and labor market signals. Keep an eye towards the EUR/USD pair, as it is likely to respond strongly to any shifts in monetary policy.
Risks to this view
A significant deviation from expected inflation trends or a dovish Fed response could undermine the current bullish sentiment around the U.S. dollar, leading to a reassessment of recent positions.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Financial markets and investors are fully back in the swing as summer is quickly coming to an end and the final third of the year begins.
Investors have had to digest higher than expected August payrolls and inflation data, rising oil prices, and this week we will finally get the Fed response to these economic developments. There's also a new focus on AI safety and the implications for the AI trade to be mindful of as well. So joining me here on this Monday morning to talk about all of these factors, glad to welcome back to the table, Jason Draho, Head of Asset Allocation for the Americas from the UBS Chief Investment Office within UBS FSI.
Jason, great to be back on the mics with you here in the studio. Welcome back. It's good to be back.
Yeah, it does feel like, you know, back to business after an enjoyable summer. And focusing on the year end. Exactly.
This is a sprint for the next few months. Definitely. So Jason, our conversation today in part will focus on your recent blog, which is available now up on UBS.com slash CIO, the title of your blog.
Just get on with it already. And a lot to talk about the AI safety topic, one of interest. We'll get to that a bit later, though, want to begin with the August inflation data that was released on Friday and the payrolls data as well.
That was released the week before. Talk to us a bit about the data, what it says about the state of the U.S. economy at the moment. A word I've used on this podcast before in other situations is, you know, I describe the U.S. economy as kind of relatively benign right now, which might seem kind of surprising given a lot of these risks that are going on, given concerns about inflation.
But if we just look at the inflation data and get into some of the details, you know, the core CPI, which is kind of what feed into the core PC that that focuses on, it rose by 29 basis points month over month. It was above expectations, which is around, you know, 25 basis points. There are parts of it that were firmer, you know, that kind of contribute to the rise, including like wireless, you know, phone services increased by about 10 basis points.
So that alone, the cell phone plans kind of increased quite a bit. Telephone services were also firm. There were also aspects that were on the kind of the softer side, including shelter categories that were sort of more benign than expected.
So you know, all told, based on the details from CPI and PPI, the core PC price index is sort of expected to rise about 26 basis points in August, and we won't get that date until later in September. So it wasn't, I'd say, bad, but it wasn't like clearly kind of good. So, you know, kind of overall, you know, but I think if you start to look at some of the details, it sort of tells a little bit, you know, kind of better, you know, picture is really not overheating.
You couple that with the jobs data that we got the prior week for August, it surprised also to the upside, but more clearly, there was a total of 163,000 jobs created, and the private sector was 127,000, both behind expectations, and the prior two months of June and July were revised higher by 55,000. The key thing is there's a lot of month-to-month volatility in all this data, and the three-month kind of average growth was about 75,000 for the private sector, 71, you know, overall. Prior to the August jobs report, that number was 20,000 kind of three-month moving average.
So we went from 20,000 to 71,000, so it's like a pretty big jump. There isn't a sort of assumed or expected or estimated, that's probably the best way to describe it, of estimated sort of trend drop growth, like how many jobs need to be created to keep the unemployment rate steady. Those estimates vary, but 71,000 is probably at the high end of that range, if not a little bit above that range.
So overall, kind of strong results. If you looked at the wage data, the combination of job gains, average hourly earnings went up, job growth, it suggests that all measures of payroll employment went higher. So labor market kind of solid, resilient, inflation data, a little bit above expectations, but still, you know, relatively, you know, kind of, you know, solid, you know, not necessarily indicative of an economy that's overheating.
So you add it all up, this does suggest that the macro conditions in the U.S. economy, everything else considered, is relatively benign. Given that assessment, Jason, accounting for the state of the labor market, the inflation situation at the moment, the big question is what this means for the Fed. So what does CIO expect the FOMC to decide on Wednesday when they meet, and what does it mean for monetary policy beyond that?
Despite the fact that, you know, the inflation data, my characterization of the economy is benign, it is still, you could say, you know, if that's the case, policy is not clearly kind of restrictive. And given sort of the Fed's concern about inflation trends clearly being going lower, one could argue that the inflation data on Friday was – doesn't sort of meet that threshold. Not bad, but not sort of so clearly kind of, you know, good enough the Fed can sit on the sidelines.
So as a result, from pre to post, the inflation data, the market pricing for a hike this week, you know, in September, went from about 72% to close to 90%. At those kind of levels, that's what the market expects, and it would be surprising for the Fed not to follow through given those market expectations. We are in the blackout period, so the Fed can't comment on this, so all we can do is sort of, you know, infer what they would likely do.
Given strong jobs data, given Kevin Warsh, Fed Chair's speech at Jackson Hole, that was quite hawkish, it would be surprising if they, you know, if they didn't hike. I think beyond this week, though, that's where maybe the outlook becomes a little more uncertain. You know, our official forecast is one hike in September, one in December, then an extended pause that would go well into 2027 with the next move being a cut.
But I think, you know, after this week, I think it's kind of an uncertain path. You know, it's unusual for the Fed to start raising rates and do it only once because they're going to start a hiking cycle under the assumption that it's going to take multiple hikes to kind of cool the economy. You know, if you're really overheating, as it was in 21-22, you need multiple hikes.
Even if you think it needs more of a calibration, you still probably need to do a few. So it would be unusual for them to go in thinking it would be one and done. But there are exceptions, and, you know, the 1990s provide a good example and a template that we've talked about for this decade.
The Fed hiked one time in March of 1997 after being on hold and cutting rates back in 1995-1996. And after one hike, they stayed on hold for 18 months, and their next move in September of 1998 was a series of cuts. So you can almost look at that as a mid-cycle kind of recalibration given the data, sort of similar to now.
This feels like if there's a hike, it could be sort of in a hike to sort of adjust after doing some insurance cuts last year. So more of a calibration of that. Also working against, I think, a longer hiking cycle is the fact that the inflation outlook doesn't necessarily warrant a significant number of hikes.
You know, the way I say this, again, the CPI data for August wasn't so, you know, much that it was bad, but it clearly wasn't good enough for the Fed to stay on hold. But if you look at the annualized core PC inflation over the last few months, it's going to be roughly 2.5%. Now the headline number year over year is still around 3.1, 3.2, but the underlying disinflation trend is still there.
After the end of – at the end of September on the 30th, we will get an updated estimates of inflation based on methodology changes that they're going to do to calculate things of such as financial services to certain software categories that will lower core PC. But then looking further out, there'll be base effects that really kick in next year that's going to cause a pretty – expected to cause a pretty steep decline in inflation readings. If you forecast where you think inflation will be in roughly 6 to 8 months from now, you plug that into like a policy rule, you know, a tailored policy rule that, you know, central banks often follow.
If you plug that in, it would suggest today, you know, the Fed shouldn't be doing anything policy is not actually – doesn't require hikes. Current inflation suggests there is hikes. So again, once you get to December, inflation is going lower and their forecast is like suggests it's going to keep going lower, it's kind of harder to argue like why you continue to hike.
So I think it doesn't mean they won't. It just means I think after this week, you know, which is I think is close to a done deal or should be very, very unlikely, I think it becomes much more uncertain after that. We will have Andrew Dubinsky joining us on top of the morning on Thursday morning for a quick reaction, reflections, thoughts on the outcome and what it means for monetary policy as we make our way into the latter part of 2026.
So Jason, let's talk a bit about the markets at the moment. It was interesting heading into Friday. It was a bumpy road for equities last week, though we did see the markets respond positive to the Friday inflation data.
What do you think that was? Oil prices are down 3% on Friday, which some would point to, but I think the biggest thing was that inflation data, you know, even though it was a little hot and the market pricing went higher, it actually reduces policy uncertainty. So basically the market says, all right, the Fed is going to hike.
This is what we have been sort of pricing for a long period of time. Now we kind of get rid of that sort of policy uncertainty to the point where investors sometimes dislike uncertainty so much. They might like this more than like if the Fed actually hikes 25 basis points given what's already kind of priced in.
In terms of then the outlook, you know, why the markets responded the way they did and just to kind of give some context, the S&P 500 was up 0.9% on Friday. The 10-year and the 30-year treasury yields were flat to down 1%. So kind of again, maybe we're reflecting positively on how the Fed actually hiking is a good thing because it sort of stabilizes the back end of the curve.
The two-year treasury yield did rise 4 basis points and had risen already 22 basis points earlier in the week. Gold was up even though rates were higher because again, kind of reestablishing maybe some sort of Fed credibility. So I think that kind of stems from this policy clarity.
And then going back to like what is the Fed going to do, you know, the market is already priced for multiple hikes. So if the Fed does one or even two, that's expected. So yields itself shouldn't rise and the market reaction on Friday is consistent with that.
The growth impact for the U.S. economy should not be really altered very much by even a couple of rate hikes. You know, just sort of the typical kind of relationships would suggest that GDP growth would be negatively impacted by maybe 10 or 20 basis points, all else equal. You know, everything else is constant.
That still should leave U.S. growth for the next year around 2%. And so given the other factors taking place to be 2.1 versus 1.9, not a material sort of difference if that is the end result. And part of this is if you look at the aspects of the economy, the most race-sensitive part of the economy is the housing sector.
The housing sectors are already weak, so it's sort of like, you know, can it get much weaker? You know, probably not. At least not be a big drag on growth.
We have solid consumer spending, this resilient job market, they're going to imply that monetary policy is not particularly restrictive and therefore the economy should be able to absorb, you know, a couple of hikes without being sort of too disruptive. But perhaps the biggest reason why the macro outlook doesn't change very much is that AI CapEx has been a dominant driver, at least at the margin for growth. Estimates would put it at, you know, 50 to 60 basis points of growth in the first half of this year are due to AI kind of CapEx spending and even a bit of a wealth effect from the stock prices going higher tied to the AI trade.
Given the demand for compute remains so high and it's far exceeding supply, it's hard to imagine the hyperscalers are going to scale back on that investment because interest rates and pouring costs have gone up, you know, 50 basis points at the front of the curve even if the tenure doesn't move very much. So if that doesn't change, then the growth outlook doesn't really kind of change very much. You add it all up, you know, if the macro conditions aren't really changing very much, you have more policy clarity and the Fed may not do much, you know, more than one, maybe two.
But beyond that, you can see the fine length of the market is great, you know, this stabilizes the interest rate market and we can kind of move forward from here and hence the positive reaction on Friday. With the Fed chasing likely to hike this week, what does that mean for the investment outlook? Well, not that much then if we're talking about in a macro economy that doesn't look like it's going to be very different.
If rates are already sort of pricing for – or yields are pricing for these rate hikes, if anything, they're kind of capping out sort of at the high end of the range. So I think in and of itself, the Fed hiking doesn't really change, you know, the outlook for a variety of reasons. To me, actually the bigger thing – and this kind of goes against the typical assumption that, you know, you don't fight the Fed.
If the Fed is hiking, you wouldn't want to fight it. But it's given where the market is already pricing, to me, the bigger concerns would be as risks to the outlook in the near term as the situation in the Middle East get worse such that the oil prices keep going higher. We've seen Brent crude was up $9 last week.
It's up, I think, $14 just in – 14% just in September. If that continues to go higher, that will be a problem for the economy, for diesel prices, for long-term interest rates. And the others – and you kind of mentioned this at the outset – these concerns now about kind of AI safety, you know, the idea of sort of slowing down at the frontier of these models.
As we head now into kind of the home stretch of the mid-term election cycle, it's become politically a big issue, you know, should there be more policy constraints and actions to curtail it. So that could be a bit of a, you know, weighing on the markets. I think as a practical matter, that's probably not going to dramatically impact what companies are doing.
Again, because the supply and demand imbalance is so extreme. Even if it kind of cools demand, it still far exceeds what is supply and the need for investment. But these are, I think, the factors – AI, oil prices – are probably bigger drivers, you know, for the next couple of months, more so than the Fed hike.
And it's almost like if we get the Fed hike in, it's just we move that to the sidelines and we can focus on these other things for the time being. From a positioning standpoint, Jason, as we begin to close out, given these factors, what is CIO recommending at the moment? Well, it's still a relatively constructive view.
Still find equities attractive with good upside over the next, you know, 6 to 12 months. We've been reiterating for a while that, you know, you want to be kind of diversified in your exposure across your different segments of US equity markets, but also kind of global equity markets. And now in light of these AI sort of safety concerns, you know, the team does not view this as a negative for the AI kind of, you know, kind of invest story overall.
But it does argue for that you need to have a diversified approach across, you know, kind of the whole AI value chain, which, you know, would span from semiconductors to networking kind of companies, to power, to cloud infrastructure, to software, the whole range. And so it's kind of, you know, be diversified across that because even if, you know, paradoxically, if there's strong demand, but there's constraints on producing supply, that makes, you know, the prices of, you know, perhaps semiconductors go even higher. It's the end users that would actually, you know, be to pay the price for that.
So just having that kind of broad exposure is important. The other parts I think, you know, to think about, you know, the fixed income universe and landscape there, as rates have risen to levels that have become, started to become kind of much more attractive from a risk war perspective, our fixed income team did upgrade preferreds and investment grade corporate bonds to attractive at the end of last week, because they're longer duration, longer maturity instruments. So yes, yields could go a little bit higher.
But if our macro environment and our inflation environment plays out, if the Fed hikes only twice, not the 3.7 times the market's pricing, yields actually go lower. And that's going to benefit longer duration fixed income, you know, other, you know, more than that. And then commodities, you know, given the benign macro environment, given what rates go lower, you know, gold should be sort of a beneficiary for that.
So while there is certainly risks involved in the next month or two, I think especially going into midterms could be kind of choppy. I think the fundamental story is still relatively constructive. And then once we get past that, I think the macro conditions should again sort of be benign and benign is is not a bad environment for for investing.
Jason, a whole host of factors influencing market activity, investor sentiment at the moment, it will be a busy fall ahead of us. And I do look forward to hearing your thoughts on the Fed meeting outcome when we speak again next Monday. As mentioned, your colleague Andrew Dubinsky will be joining me here on top of the morning for a quick reaction on Thursday morning, though, Jason, thank you again for dropping by.
It was great to be back with you here at the table. You're welcome. Have a good week.
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