Top of the Morning: CIO Strategy Snapshot - Navigating the uncertainty
The desk believes that the recent tariff announcement will continue to drive market volatility and heighten risk aversion among investors. Per the full note source, Jason Draho of UBS highlights a sell-off across global equity markets, with the magnitude of the tariffs exceeding expectations and various sectors, particularly semiconductors and pharmaceuticals, potentially facing further sanctions. This uncertainty can lead traders to seek safer assets, influencing currency movements, especially in pairs linked to commodities and risk sentiment.
What the desk is arguing
The desk identifies the recent increase in tariffs as a significant trigger for volatility in the FX markets, likely leading to preferences for safe-haven currencies. According to Jason Draho from UBS, the unexpected depth of tariff rates announced sent shockwaves through global equity markets, marking a phase of heightened investor caution.
The announcement detailed a near-instant implementation of a 10% tariff across a wide range of goods, impeding the previously stabilized market sentiment. The implications for sectors like semiconductors may drive further tariffs, intensifying investor concerns and, consequently, market fluctuations.
Where it sits in our coverage
Our current consensus target sits at 1.075 within a range of 1.04 to 1.12. Key firms positioned around this target include: - JPMorgan targets 1.10 for Mar26. - BofA sets a lower target of 1.04 for the same tenor.
The desk's view aligns closely with the upper bound of the consensus range, indicating a cautious perspective on current market dynamics influenced by the rising tariff concerns.
How other firms see it
Most aligned firms, including JPMorgan, are echoing concerns over increased market volatility leading to risk aversion, while BofA offers a more pessimistic outlook. This division in sentiment highlights differing strategies in navigating potential currency fluctuations under market stress.
In addition, the relationship between tariffs and the EUR/USD remains crucial as traders reassess positions based on global risk sentiment driven by geopolitical tensions and trade relations. It's essential to monitor how these dynamics unfold in the context of the upcoming fiscal quarters.
02Concerns about further tariffs may intensify caution among traders, leaning toward safe havens.
03Market sentiment can be significantly influenced by sectors like semiconductors facing potential tariff hikes.
04Current consensus indicates an upper-bound projection of 1.075 for EUR/USD amidst ongoing uncertainties.
Market implications
Traders should watch for volatility around the 1.075 level as further developments on tariffs unfold. The market's reaction to safe-haven flows, especially involving USD and JPY, will be crucial in the coming sessions.
Risks to this view
A reversal could occur if diplomatic negotiations reduce tariffs or deliver clearer paths towards trade resolution, restoring investor confidence and leading to renewed risk appetite in the markets.
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Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. It was a historical week for the global economy and financial markets as President Trump announced new tariffs on over 60 countries.
This was more than what investors expected and markets didn't like it or the uncertainty of how this will play out. So joining us today here in studio to discuss the tariff announcement, potential paths forward and how to navigate the uncertainty. Glad to welcome back Head of Asset Allocations with the UBS Chief Investment Office, Jason Draho.
Jason, good Monday morning to you. I know a lot has taken place since you and I last spoke a week ago. Heading into the announcement, we anticipated some rocky conditions in the market and clearly that has taken place.
Well, good morning, Dan. You know, there's an expression, something like, you know, there are decades where not much happened. There are weeks where decades happened.
It felt like last week was one of those examples where maybe a week of a decade happening in a short order. Yeah, that's a perfect characterization of it, Jason. So let's get right into what triggered this sell-off across global equity markets.
What do you expect from here with respect to tariffs, Jason? Will they get worse or are there potential off-ramps for tariffs? Well, if you go back to last Wednesday and what was announced on kind of Liberation Day, the tariffs were higher than investors expect.
I think almost, you know, maybe except the most pessimistic investors was not expecting the magnitude of what is announced. And there has been sort of so far now walking them back and there's potentially more tariffs to come in certain sectors that were, for example, like semis and pharmaceuticals. So I think the investors are kind of waking up to reality that this is now happening.
Like they're already at 10% tariff across the board is in place. The incremental tariffs across individual countries that are kind of more customized, they take effect on April 9th. So really kind of the question is really, you know, that I think investors are asking at this point in time is, you know, when it comes to the tariffs, you know, are they done?
Will there be more? Could there be escalations in response to what China announced on Friday? The EU has not announced any response, but it's likely to happen, you know, this week.
Does that lead to an escalation or does it lead to negotiation? We don't know how long, you know, that, you know, President Trump would want to leave this in place. Like, is this just a permanent feature that until trade balances get down to zero, we will have these tariffs in place?
Or is it all still about kind of creating, you know, leverage, you escalate, create stress, and then you, you know, you have countries come in and you negotiate and you cut a deal. That's what the view that investors have had, but they didn't think it would get this far. So I think, you know, that's kind of the open question is where do we go from here?
Our base case at this point in time is that, you know, after a sort of initial phase in which the tariffs probably could go higher, just because you could see some retaliation, just because these exempt sectors will probably have tariffs imposed, that after that happens, and this might be a few weeks and maybe a month or more, that ultimately effective tariff rate should start to come down as we get into like later in the second quarter, or the third quarter, because of maybe legal challenges, you know, because of, you know, political pressure, as you know, as Trump's approval rating comes down, other Republicans kind of, you know, start to press more business leaders, you know, come out, you know, more against these. And we've already saw over the weekend, you know, some prominent people on, you know, on tweeting out, you know, this is a mistake. And of course, if economic data gets worse, so the pressure will kind of build.
There are talk about, you know, maybe deals and certainly countries like Vietnam and Cambodia have said, like, we'll lower our tariffs. That's certainly an incremental positive, you know, sign of dealmaking. But you really, until there's, you know, negotiations and movements on, I would call it like the big five, which would be, you know, Canada, Mexico, so like North America, the EU, China and Japan, because, you know, the biggest, you know, that's the majority of US trade is going to be with those kind of five, you know, partners.
We saw China retaliated, I think de-escalation there is going to be hard to come by. Any progress on Canada and Mexico probably has to wait until the Canada election on the 28th, so three weeks from today. Maybe there's an off ramp there to talk about reducing tariffs related to fentanyl immigration and they can claim sort of victory, you know, on that front.
But there's a lot of kind of guesswork in all of this at this point in time. You know, again, I think the baseline of things probably get worse before they get better is reasonable. If we think of the effective tariff rate, and this is sort of like how much money is raised from tariffs divided by the total amount of, you know, trade.
Right now, based on sort of what's been announced and the, you know, the typical trade of like around $3 trillion, it's a neighborhood of around 25%. It could go as high as 30, probably not more than that. But ultimately, we're sort of assuming it's got to get down to about 15% and do so by the third quarter.
Otherwise, you know, recession risk starts to become much, much more likely. So with that, Jason, is a recession now likely from your vantage point? There's a lot of questions out there, of course, about the path forward for tariffs, which at some point we will receive some clarity on.
But a lot of investor concern is stemming over how this will impact the economy over time. Well, if you were to write down a simple economic or mathematical equation, say, what's the probability of recession, it has to be a function of what your assumption is regarding tariffs. How long they stay at these current levels?
Do they go higher? If they go lower, how soon? And how much do they go lower?
So whatever assumption you want to put in there, that's going to dictate, you know, your probability of recession. We're assuming at this point in time that the tariffs will sort of come down soon enough that a recession would be avoided. But you know, you could say it's like at least, you know, 30%, 35% chance of that sort of not happening, like the tariffs stay elevated for long enough that this becomes a serious problem.
But again, that's kind of, you know, kind of guesswork at this point in time. The one thing that we do know is that the economy has kind of came into this year overall in relatively good strength. You know, back three months ago, the consensus forecast for GDP growth this year was around 2.3%.
Strong momentum at the end of last year, moving into this year. We saw some bumpiness in the data for consumption in January and February. Not a lot of that.
I think it's sort of predicated on the fact that there's some seasonal patterns. We saw the exact same thing happening from 23 to 24, that the consumptions fell at the start of the year after a strong fourth quarter. There were weather problems.
We haven't yet got, you know, March data. But there could be a lot of actually a bit of a surge in the March data for consumption because of people front running tariffs. We know auto sales, you know, absolutely surged in March.
They annualized at 17.7 million. That's the biggest monthly increase since I think, I believe it was April of 2021. And again, people are buying cars before prices go up on anticipation of tariffs.
The labor market data we got on Friday was better than expected at around, I think, 229,000 jobs. So roughly almost 90,000 more than expected. Prior two months were revised a little bit lower, but on net a good report.
The household survey, you saw job growth there. The unemployment rate ticked up slightly, but we're talking about going from like 4.13 to 4.15, you know, minor. Normally that'd be a good report at a time when people are concerned about, you know, the economy, but at a time when the focus is so much on tariffs.
In some way that was an example of like maybe, you know, good news is bad news because it makes it harder for the Fed to justify, you know, rate cuts, but also gives President Trump reason to think, well, the economy is strong. He even tweeted out, it's already working. It's a bit of a stretch to say that job growth in March was because of tariffs, but that's kind of an example where, again, good strength, but it has sort of, you know, some consequences and maybe making this prolonged and actually, you know, good now, bad later on.
Ultimately, it really kind of just depends on the tariff assumption. So I think growth of like sub 1%, but not recessionary for the full year as possible. Could we get a quarter of negative GDP growth?
That's certainly possible. But, you know, at this point, we'd say like if it's a recession, it's a very mild recession and still positive growth for the year, but it's very much contingent on how the tariff scenario plays out, which means there's a wide range of outcomes. So Jason, how do you think the Fed is interpreting all of these developments?
I know the White House has been pretty outspoken about the want for rates to come down, but just given economic conditions, what they currently are, I know we have inflation data coming out later this week. How do you think the Fed might respond here? Well, tariffs are sometimes the, you know, the worst possible situation for the Fed because they are inflationary, certainly in the short term, but they can also be a drag on growth.
And so trying to balance their dual mandate of dealing with price stability as inflation is already above the 2% target and is likely to go higher could easily surpass 4% for core PC inflation. At the same time, the risk is that the unemployment rate starts rising. So how do they kind of balance it all out?
What we'd expect is that the Fed is going to still cut 75 to 100 basis points this year because of just kind of some moderation of growth. Powell made a comment on Friday when he was at an event and doing a Q&A and asking questions from reporters that he did say, you know, while tariffs are highly likely to generate at least a temporary rise in inflation, it's also possible that the effects could be more persistent and their obligation is to make certain that a one-time increase in the price level doesn't become an ongoing inflation problem. So before the Fed would look through inflation, they think it's sort of transitory.
He actually used transitory at the last Fed meeting regarding tariffs. That's an example where they may be a little bit more concerned, given the magnitude of the tariffs probably higher than what they were modeling out. So there's an issue where maybe the Feds, their hands are tied a little bit.
Market pricing right now has about a 50% chance of a Fed cut when they meet in early May. It's May 7th. But when you go to June, in a mid-June meeting, it's around a 1.5 cuts are being priced in and by year-end, over 4.5 cuts at this point in time.
So their hands are tied, but the reality is that the Fed could also pivot quite quickly if necessary, whether it's on labor market weakness, but also stress in financial markets. So the Fed has a dual mandate, full employment, price stability, but they actually have a third kind of mandate, which is financial stability. So something that we're watching closely, that the markets will watch closely, and the Fed certainly will be is, are there stresses in financial markets and funding markets?
Are they functioning okay? Are we seeing signs that they're kind of breaking down, they actually have to kind of intervene? And one of the ways they do it is providing maybe liquidity facilities, but also just cutting rates and signaling to markets, like we will have to step in and intervene.
The market volatility is high, liquidity is low, but I think they're still, based on all accounts across different asset classes, equity, credit rates, FX, they're still functioning. So not yet the kind of stress that would suggest the Fed needs to kind of step in and cut. But at the same time, if we also think if the Fed doesn't cut, monetary policy effectively is becoming more restrictive as we speak.
And a simple way to do that is if you look at financial conditions, which are based on, some measures are based on equity prices, credit spreads, rates, the dollar, the widening of credit spreads significantly in the last week, and I think high yield spreads in two days widened about 90 basis points, in addition to the S&P being down 10% on two days, Thursday and Friday. The tightening of financial conditions was almost equivalent to like one full rate hike, depending on how exactly you calculate it. So just holding steady means policy gets tighter.
If the Fed thought before policy was kind of well calibrated, sort of balanced between higher inflation and slower growth, well then policy is actually getting tighter. So they would actually need to cut if this persists in some way. So I think they would have justification for moving relatively soon if necessary, and even doing so almost like on a risk management perspective.
And we've seen, even in just the past few years, the Fed has been willing to pivot. Last September, after some signs of weakness in the labor market of summer, the Fed did 50 basis points. The following fall, in November, December, the Fed kind of pivoted from the market thinking they might still hike more to basically saying, you know, we're done and we can actually do preemptive cuts.
You can go back to 2018-19, they hiked rates to 2.5%, and then, you know, in December, and then by January, they're kind of saying we're probably done and maybe have to ease off a bit. So they can pivot very quickly, but, you know, things may have to get worse before they get better from the Fed's perspective. So the Fed is clearly spinning a lot of plates at the moment.
Looking at the markets, as we're recording here, Jason, on a Monday morning, about 10 minutes to go before the open. Looking at the equity futures, they are off their lows, though the S&P 500 is close to entering a bear market, being down roughly 20%. What is CIO's outlook for equities from here?
And how should investors be thinking about this volatility? How should they navigate it? Well, look, this is our, you know, in the near term, you know, the bottom line is probably to more volatility.
So being off the lows of futures, I think they were down about 3%, being off 2%, you know, normally, that'd be a big move. But after, you know, two days of like 5% and 6%, roughly, it seems kind of, you know, mild in comparison. I think a way to kind of think about it is, you know, how much is the market falling?
The S&P is down as of Friday's close, about 17.5% from its all time high. To be down 20%, you know, and 20% is kind of the bear market, you know, levels, would be just over 4,900, so it gives some sort of perspective. The average drawdown in a recession is 32% for the S&P, a little over.
So just if you're at 20%, well, right now at 17%, we're at a little more than 50%. At 20, you're getting around 60%. And say, as a really crude back of the envelope assessment, you could say, well, now we're pricing in roughly 60% chance of a recession, or maybe quite a mild recession.
You know, there have been 12 drawdowns of at least 20% since 1945. You know, the average drawdown then, conditional on being 20%, was 34%. Once you hit that minus 20%, and suppose we get there, you know, the end of today, the 3, 6, and 12 month returns averaged 4.4%, 3.3%, and 12.9%, so almost 13% a year later.
And that was about a 65%, 67%, let's say two-thirds hit rate, meaning you're up, and when you're up a year later, you're up by almost, you know, 13%. If you take a longer horizon, it's three years, yeah, the total return is 29%, and five years is 52%. So kind of average, you know, 10% annualized returns, with very high, you know, hit rates of 90% to 100%.
So long-term investors, again, these would be, you know, decent entry points, but certainly can go, you know, lower, and in fact, on average, like, you know, they have gone lower because of, you know, recession situations. So if we avoid a recession, it's a good entry point, you know, but, you know, I think we'd say we probably will, but I think near-term, you know, it's certainly possible we go lower. Our price target for the year-end is 5,800.
Ultimately, we think economic conditions, especially once you look into 2026, whatever growth hit we get now is kind of, you know, will be, you know, through the summer, as things start to improve next year, there should be fiscal stimulus, at least in terms of extending tax cuts, maybe some marginal more tax cuts, you know, some deregulation that could be incrementally positive for growth, and the markets will then start to price off of that. So the 5,800 is based off of, like, what are the earnings, not for this year, but, of course, for next year. And this year, we're basically expecting flat earnings growth.
Next year, sort of resumption of positive earnings growth. So that's kind of where you get to, you know, the upside. But until then, you know, there could be certainly more downside and a lot of volatility.
Until we see clear off-ramps, whether the Fed starts to cut rates, whether there's signs of de-escalation, so we have the escalation, and then the de-escalation on phase on tariffs, and that could happen, you know, or may not happen until at least, you know, for another month or two. So some choppiness until then, and certainly very sensitive to any headline news or news on tariffs, any escalation, there's certainly some more downside. But just wanted to put those numbers in context, because, you know, everyone can sort of judge for themselves, like, what is their pain threshold, where they want to sort of, you know, start to wade in.
I think at these levels, we're probably not at the point where this is a compelling risk score, but, you know, 20% down, I would imagine some investors will be stepping in to kind of buy, thinking, I can't time it, this is a pretty decent entry point. Well, Jason, very helpful context to perhaps inform decision-making when it comes to equity positioning. Just looking outside of equity markets for a moment, Jason, what else can investors do, just looking at other asset classes to navigate this uncertainty?
Well, look, you know, taking advantage of volatility in ways in which it's hard to predict with the direction of equities, that using, you know, some capital preservation strategies or structured solutions, you know, they can limit the downside, maybe you give up some of the upside, but they're a way to sort of say, you know, I mean, below this threshold, below 2,400, I feel like I want to cut the downside, or 4,500. Those things you can do to alter the risk profile. So instead of being at the whim of what the markets are doing or what policymakers are doing, you can kind of, you know, alter your risk, you know, profile.
So that is certainly one way to think about it. Look, we've seen spreads widen out. For riskier credit, they could certainly widen out even more, which is why we'd still have a strong preference for quality fixed income.
You know, this includes things like, you know, agency MBS, which are quasi-government securities. They tend to do relatively well, you know, in periods of stress and economic uncertainty. So that's something that we continue to like.
For in terms of duration, our price target or yield target for the 10-year at year end is 4%, and we're right around there now. I'd say it's a little bit sort of a binary, though. Like if we get a recession, you know, and the Fed's cutting more aggressively than we assume, you're probably going lower, like, you know, 2.5%, sub 3%.
But if we avoid it, and the economy ends up being okay, there is a possibility that to offset maybe the headwinds from tariffs, that the administration with the Republicans in Congress could pass a bigger sort of fiscal package than anticipated. You know, and there's already what was the Senate pass was, you know, more sort of looser than what the House was passing. And there is definitely pressure on the administration or from the administration to move forward on that.
So you're going to end up having bigger deficits going forward. If the Fed has to sort of act somewhat preemptively while inflation's high, you risk inflation sort of taking longer to come down, and then persisting. So bond yields could easily kind of drift higher.
So it's not quite symmetric, but definitely there's an upside scenario that investors have to keep in mind. All of which is to say, at this point in time, probably want to shorten duration and make long duration bets. You can get, you know, five years or less, you know, obviously high quality, you know, fixed income without taking, you know, the interest rate call.
And if the Fed is cutting, you're going to get still some of that duration piece there. Gold sold off on Friday. It has done very well as a diversifier, as a kind of a hedge.
I think on Friday, that was probably due more to some margin calls, some de-risking like investors were kind of in general selling stuff. But I think fundamentally, there's still a diversification argument for gold this time. And just back to equities, you know, we still like, you know, the tech sector, we still like the AI theme.
You know, the Nasdaq is down more than 20%. This tech sector sold off more than others. If you look at the relative valuations of tech and Mag 7 in general versus the overall market, it hasn't been this kind of, you know, relatively cheap, you know, in a number of years.
And these are stories that have still secular kind of growth themes, less kind of economically sensitive, high quality companies. Again, sort of maybe if you're looking to kind of add exposure, those are areas to consider adding. Well, Jason, a lot of considerations there when it comes to positioning for our clients of UBS.
Listening in do, of course, encourage you to have a conversation with your UBS financial advisor when it comes to allocation decisions, though, Jason, this was a very helpful conversation to begin the trading week. Thank you very much for coming by, sharing some perspective on what you've seen, what this may mean for the markets, the economy going forward. And of course, the guidance when it comes to portfolio positioning.
Thank you again, Jason. You're welcome. And have a safe and less volatile week, hopefully.
Hopefully. Likewise. Thank you, Jason.
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