Top of the Morning: CIO Strategy Snapshot - Navigating geopolitical & policy risk
The market is poised for heightened volatility as geopolitical tensions between Israel and Iran escalate, with significant ramifications for global oil prices and economic activity. Per the full note source, UBS suggests that these military confrontations likely disrupt not only regional dynamics but also impact the broader U.S. and global economies through higher oil costs. Additionally, with pivotal events like the G7 summit and the FOMC meeting approaching, traders should brace for potential shifts in market sentiment influenced by these developments.
What the desk is arguing
The desk identifies geopolitical tensions, particularly the ongoing conflict between Israel and Iran, as critical drivers of market disruption. High oil prices are expected to be the primary channel through which this escalation affects economic performance amid an overarching climate of uncertainty.
In this context, oil prices, already under pressure from previous supply constraints, may rise further as the situation escalates, impacting both inflation and central bank policy. UBS highlights that current market players are likely to react more strongly to the economic implications than to the geopolitical situation directly due to the challenges of forecasting military conflicts.
Where it sits in our coverage
Our consensus target is 1.075 for the EUR/USD pair, with a range between 1.04 and 1.12. Notably, jpmorgan estimates a target of 1.10 for March 2026, aligning closely with our view, while bofa holds a more pessimistic position with a target of 1.04.
This consensus reflects a slightly bullish sentiment in the face of potential geopolitical disruptions, placing our projection nearer the upper bound of the range established by competing firms.
How other firms see it
The broader market sentiment appears aligned with the view that geopolitical tensions will affect economic conditions, particularly among firms like jpmorgan and goldman sachs, who expect volatile movement in response to global events. Conversely, firms such as bofa maintain a bearish stance, indicating caution in the current environment.
Traders should monitor movements in oil prices as this could lead to significant indirect effects across currency pairs, especially in the EUR/USD trajectory relative to the expected direction of U.S. Federal Reserve policy.
What the calendar says
With the G7 summit and the FOMC meeting on the horizon, the market should be prepared for announcements that could pivot current sentiments and impact currency valuations significantly.
01Geopolitical tensions between Israel and Iran are increasing market volatility, with implications for oil prices.
02Higher oil costs could disrupt both the U.S. and global economies, leading to potential shifts in central bank policy.
03Key upcoming events, including the G7 summit and the FOMC meeting, may further influence market dynamics.
04Consensus projections suggest a bullish outlook for the EUR/USD, closely following the sentiment around geopolitical risks.
Market implications
Traders should closely monitor oil prices, which are likely to react sharply to any escalations in the Middle East. Additionally, the upcoming G7 and FOMC meetings could serve as catalysts for significant currency movements, potentially revising forecasts based on economic sentiment.
Risks to this view
A sudden de-escalation in Middle Eastern tensions or a drastically more dovish stance from the Federal Reserve could invalidate the current bullish outlook, leading to a sharp reversal in trader sentiment and positioning.
ubs
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
At the start of a new week, geopolitics are likely to dominate the headlines and likely market activity. Military strikes between Israel and Iran continued overnight without signs of obvious de-escalation. The G7 summit is occurring in Canada on Monday and Tuesday of this week.
We do have the Fed's FOMC meeting taking place this week. So, Jason, a lot going on. So, thank you for joining us to talk about these events, the potential market implications of them.
And, of course, we'll spend some time on positioning. By the way, of course, we're joined today by Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office. Happy Monday morning, Jason, to you.
Thank you for dropping by. Good morning, Dan. Happy Monday.
Good to be here in person again. Absolutely. So, it was an eventful weekend when you think about geopolitics, Jason.
Let's begin with that. In the Middle East, we have been witnessing ongoing fighting between Israel and Iran. Of course, first and foremost, the human toll very unfortunate to see, though, of course, we need to talk about the risks this perhaps poses to the economy and markets.
So, what are your thoughts as of this morning? Well, it's always hard to put a probability on when there's military, political war events, what's the likelihood of escalation or not escalation? And therefore, how likely is this to become perhaps a regional war that occurs over an extended period of time?
Because at the moment, there's not obvious off-ramps in terms of how this could be de-escalated. Given that it's hard to quantify that probability, what the markets, investors will tend to do is instead focus on what is the economic impact of this happening, and that's disrupting the US economy, the global economy in some way. And realistically, there's two main channels.
One is through these high oil prices, through disrupted supply. And then the other is maybe like disrupted trade patterns, particularly through the Persian Gulf, but this West Canal, through that part of the world. That could disrupt trade.
But primarily, it's going to be higher oil prices. What we know as of this morning, it's Monday morning, is that there doesn't seem to be much impact on actual oil put and exports. So, oil prices have gone up from a low of around $60 a barrel up to close to $78 now, down to about $75.
So, like a good 25% increase. But because there doesn't seem to be a disruption of supply, that increase right now in the price really reflects more of a risk premium that supply could be disrupted. The longer this goes on, there's greater risk of something escalating.
It's also the longer it goes on, perhaps Iran in particular would be incentivized to do something where they have a blockade of the Strait of Hormuz to try and curtail oil shipping out. Things that would have caused oil prices to go higher, that would cause stress in the global economy. And therefore, you'd have countries such as the US want to lean on Israel to look to de-escalate because this is starting to have a negative impact.
We're not there yet. So, that's kind of how things potentially could play out. Again, sticking with the economic argument, quantifying what would be the consequence.
A rough kind of rule of thumb is that $10 increase in the price of oil per barrel would roughly translate into about a four basis point increase in inflation, all else equal. So, in an environment where inflation is likely to go higher because of tariffs, that has been sort of moving in a positive direction so far this year. The four basis points in and of itself is not a game changer for kind of all the noise and other uncertainty kind of tariff related.
But if there was an escalation that would cause the price of oil to go over $100 a barrel from where it was at $60, well now we're talking that's a 20 basis points impact on inflation, which just further exacerbates the trend in inflation if that materializes. So, that just kind of quantifies it. And then of course, it has a negative impact on the U.S. economy if prices rise too much, more so for the consumer, even though the production side of the economy, because the U.S. is the biggest oil producer at this point in time.
There is an offset there. If we leave that aside, the U.S. economy, the data we got last week shows that it is still holding up relatively well. Things are slowing a little bit in the labor market, but nothing that would indicate a real kind of falling off a cliff.
So, given all that, if you look at the price action from last Friday, it's consistent with what you sort of expected. It was a risk-off day, you know, equities sold off, credit spreads sold off, but the treasury yields actually rose. They kind of rose more, they kind of dolled back as the day went on.
The U.S. dollar did strengthen a little bit, but not exactly a real kind of flight to safety bid for U.S. assets. And the dollar rallying will be consistent with that, but also a flight to safety going into U.S. Treasury's yields going lower, but in fact they went higher.
And now what we're seeing on Monday morning is kind of an unwinding, a fading perhaps of this trade. Equity futures are up. You've seen the dollar weaken, you know, the more beta, high beta currencies are rallying.
Treasury yields are rising. Again, directionally it looks like a risk-on environment. And so that's an interesting sort of dynamic, consistent with the market saying to look through these Middle East events as being somewhat, you know, relatively insignificant from an economic perspective for the U.S.
The key thing that was interesting is the flight to safety did not necessarily occur for U.S. assets, you know, both on Friday and certainly again this morning. So, Jason, I will point out quickly that this, of course, a very fluid situation. We're recording around 9 a.m.
Eastern on Monday morning for our listeners likely to tune in a bit later in the week, though putting that aside for a few moments, do want to turn over to the G7 meeting, as mentioned, taking place this week, today, Monday, as well as Tuesday. Is this a risk event for the markets, whether that be a positive or negative? It is a bit more of a question mark.
You know, there's potential for either way. So on the positive side, there could be some announcements of frameworks of trade deals between the U.S. and Japan. There's been a lot of discussion and speculation if something could be announced.
You know, this has been sort of an ongoing issue in the markets for about a month now, thinking there'd be something announced with Japan. That has not happened, but that would be sort of a positive outcome. Another possibility is that I think the President Trump and the Canadian Prime Minister Mark Carney are scheduled to meet today.
There's been apparently kind of quiet discussions between the two kind of leaders and their kind of administrations, where there could be some announcement of at least a framework of kind of a trade deal, security deal that would allow perhaps tariffs to come down. So anything along those lines, that direction, so that can now progress is being made on different countries, I think that would be kind of welcome. The reverse is that, you know, over the course of two days, there could be escalation of tensions on trade matters, disagreements about things, you know, say between, you know, Trump and the European Union, as an example.
There could be tensions over how to deal with, you know, the situation with Iran and Israel, you know, some countries perhaps looking to, you know, try to pressure the, you know, the situation. That doesn't seem to be, like, there seems to be relative alignment so far with supporting Israel at this point in time, among at least the G7 countries by and large. But dealing with Ukraine, that could again sort of create some tensions between the US and, you know, particularly the European partners.
So it could kind of go either way, I think, from the markets perspective, and I think for a lot of participants of other countries, leaners, that they would think if we walk out of this with a status quo, things aren't worse, that would be sort of a win, as opposed to, you know, Trump's escalating things in certain ways or being disruptive. In 2018, the last time there was a G7 meeting in Canada, they were trying to get alignment sort of on a communique, and that did not sort of go well. Then when President Trump was leaving on the plane, I think, you know, there was a statement that went out that he subsequently wasn't happy with.
So there was clearly a risk that things could go kind of off the rails. So these are things that I would watch for signs of positive development, I think would be welcomed by the markets as we, as they certainly focus on our deals being developed and frameworks being outlined in anticipation of July 8, because that's when the 90 day reprieve expires. So things like that, but also any concerns of disagreement or things that would lead to perhaps antagonizing either side that would delay the possibility of deals.
Well, some interesting historical precedent to be mindful of, we'll see what the next couple of days deliver. I mentioned the FOMC meeting taking place this week as well, I will conclude on Wednesday heading into the meeting appears that the Fed will be holding steady. What are you watching for Jason as takeaways this week?
Well, it is the third topic we're talking about this morning that kind of reflects the overall kind of ranking in terms of relevance for the markets, given to the economic data holding up reasonably well, inflation data is improving, it's sort of been better than expected. But given the tariff, sort of, you know, minor tsunami that should hit with in terms of inflation, the Fed would certainly kind of look through the recent data and worry about inflation is likely to rise near term. So they have justification for, for standing impact for saying the economy is still in a relatively decent place.
They're close to monitoring the situation, which is why the market probability for a cut this week is at three basis points. So basically, you know, zero, still a little bit under 25% chance for July, only once you get to September, you know, up to kind of the 80% range, then it's still the market still pricing for two full cuts this year. So no action right now, but still the Fed beginning to cut by the end of the summer, the end of the third quarter, two cuts this year.
So what to then to watch for, if there's no actual cuts, it is changing the Fed's kind of guidance regarding the state of the economy, through the summary of economic projections, or the dot plot and whether that that changes on the dot plot at the last update of the back in March, the median dot implied two cuts this year, and the tilt was more towards being even less than that. So there's definitely a risk or possibility that the shift goes to like a median of only one cut this year. That will be contingent on what ultimately is reflected by kind of the economic projections.
When they last did this in mid March, it was they were making some assumptions about what tariffs would be what that would mean for inflation, what that would mean for growth. What we got on Liberation Day was certainly much higher than that. But we've also seen kind of a walking back.
And there is a trend towards sort of de-escalation. And they may have some information by Wednesday, what happens out of the G7, whether some sort of progress on trade deals that could also bring tariffs down. So it's kind of an open question of how much these different committee members would sort of update their expectations for tariffs, that would be mean inflation goes higher, and growth goes lower, all equal relative to where we are in March.
And that could impact you know, where the median dot goes. Given that, you know, in the next few weeks, we could get deals that further de-escalate the situation on trade. It you know, that could certainly change the Fed's thinking just in the matter of, you know, the next six weeks before they meet in July.
So that's what that's what the markets will focused on. But given the situation is so fluid from both the economic data and the policy outcomes, I think that even if they were to shift a slightly more hawkish stance, a little bit negative in the near term for the markets, but I think ultimately, you know, people would kind of look through it, given where the data is coming out. So there's a lot outstanding at the moment when you consider what you've covered for us this morning, Jason accounting for geopolitical and policy risk factors, what should investors be doing right now to navigate this all?
Well, let's kind of think about where we've been where we're likely to go. It's been a rapid recovery from the lows in early early April with the S&P up back over 6000 back to a level that was just, you know, kind of where it was prior to President Trump being inaugurated. So back kind of, you know, in positive territory there.
So very rapid recovery at a time when there's still so a lot of uncertainty on various policy matters, political matters, we haven't even touched on the past, you know, the prospects for the one big beautiful bill that will get some news probably out of a Senate Finance Committee this week, and you know, the markup. So that is also kind of progressing and what kind of changes could take place there. So a period of consolidation in the equity markets is certainly sort of, you know, understandable for the time being.
But stepping back big picture, we think we're still in a kind of a bull market. So on a 12 month horizon, still see, you know, decent upside close to 10%. But over the course of the summer, certainly could see some choppiness, both the possibility of the markets kind of melting up a little bit.
If we get progress on the, you know, early July, a budget deal is passed, trade deals are announced. At the same time, the markets are somewhat complacent on the economic impact of tariffs, and we can certainly get a bit of a soft patch in the data, the markets could sell off. So I think that's kind of the reality that we're kind of dealing with in the near term.
Given that sort of a certain environment, that's one of the reasons why we continue like the tech sector, it's more sort of secularly based. And it's really has been done, done quite well of late. The topic of US exceptional money gets kind of relevant given sort of what we talked about earlier, regarding how the dollar, you know, kind of modestly rallied on Friday, US rates actually went higher.
So they didn't really get that kind of safe haven bid. When we think about US exceptionalism, there's a lot, you know, this is a bigger conversation for another time, there's a lot of ways to kind of think about it. But one of it is that, I think, you know, US or corporate America still continues to perform rather exceptionally well.
And certainly, you know, the mega cap tech companies, the public sector, the finances of the country are certainly more challenged, it's room a little bit more unexceptional, I guess you could say it that way. If that's the case, that's more of an impact for the overall state of the economy. The asset classes that are most macro based are the dollar and rates, they're really macro asset classes versus equities are more going to be micro based.
You're seeing then, you know, the equity markets do well, because again, US exceptionalism of the corporate sector is holding up at the macro level, rates going kind of higher or the dollar weakening, that's kind of reflective of kind of more the broader economic concerns and policy concerns in the US, those are likely to persist, all this is said, you know, the dollar is likely to weaken. So when we think about kind of allocation, kind of across regions, if the dollar does weaken, if you have foreign investments, that's actually it ends up being a tailwind for investments abroad. So thinking about these different factors, it's also why, even though we like us equities, having making sure you have kind of a globally diversified portfolio, given these sort of conflicting kind of forces and factors all playing out.
And the last thing is just on on rates, you know, rates could go higher, the fact that they're actually kind of rallying again, it's even an environment where there's this uncertainty is consistent with perhaps, at the back end of the curve, in particular, being driven more by policy and politics and geopolitics than it is about sort of necessary, you know, fundamentals, that's more reflective by the two year, the five year, and we felt that's where we have more conviction in terms of making calls and where we can allocate. And finally, just gold continues to be kind of a good diversifier in this geopolitical environment. And so that's something we continue to like and see.
This is a hedge of a good role for that in portfolios right now. Jason, thank you very much for hitting on those positioning considerations, as we talked about a lot going on on many fronts at the moment. So very helpful to have this guidance and context to begin the trading week.
Thank you again for joining us, Jason. You're welcome. Have a great week. along with our video offerings, such as UBS Trending.
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