Top of the Morning: CIO Strategy Snapshot - The next chapter
In the wake of the recent US-Iran talks held in Pakistan, geopolitical tensions are likely to influence market dynamics, particularly concerning energy prices and risk sentiment. Per the full note from UBS, the escalation of a US blockade on Iranian ports is set to add layers of uncertainty to this already volatile situation. Traders are advised to closely monitor how these developments impact currency pairs sensitive to energy prices, including those involving the Iranian rial and the US dollar, as any further escalation could significantly alter the trading landscape.
What the desk is arguing
The current geopolitical tensions stemming from the US-Iran peace talks are expected to create ripples across the FX markets as traders seek new narratives. According to UBS, the activation of a blockade on Iranian ports is indicative of a strategic escalation that could influence energy supply dynamics (source). This leads to greater scrutiny of energy-linked currencies, particularly as the market awaits clarity on potential future developments.
With the US sanctions tightening, there is potential for significant volatility in currencies like the USD, particularly around commodities that show a direct correlation to these geopolitical events. Moreover, market positioning may begin to shift as traders reassess their strategies in light of new sanctions impacting oil supply and Iranian interactions with global markets.
Where it sits in our coverage
Current consensus points towards a target range of 1.04 to 1.12 for the USD against key currencies influenced by energy markets. Specific targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk’s call may lean towards the upper end of this range, especially considering the potential for heightened volatility in energy prices and their impact on currency valuations.
How other firms see it
Firms such as jpmorgan align with the view of an impending shift due to geopolitical tensions, while bofa diverges with a more cautious outlook focusing on stable price levels amidst potential disruptions. This divergence underscores the uncertainty in how markets may react, depending on any further updates regarding Iranian sanctions and negotiation outcomes.
Related currency pairs to watch include USD/CAD, given its strong tie to energy prices, alongside the potential spillover effects into emerging market currencies that may be affected by fluctuations in oil prices.
01Geopolitical tensions from the US-Iran talks are likely to drive FX volatility, particularly in energy-sensitive currencies.
02The implementation of the US blockade on Iranian ports adds uncertainty to market dynamics.
03Traders should closely monitor shifts in energy prices as they correlate with FX movements.
04Positioning strategies may need to adjust due to the evolving geopolitical landscape.
Market implications
Traders should keep a close eye on energy price movements, particularly oil, which could breach the $80 per barrel mark, impacting currencies like CAD and MXN. Additionally, volatility around developments from the US-Iran situation may create trading opportunities as the market reassesses risk premiums.
Risks to this view
The key risk to this outlook would be a rapid de-escalation of US-Iran tensions, leading to diminished fears of supply disruptions. An unexpected diplomatic breakthrough could trigger a strong rally in affected currencies, reversing any bearish sentiment linked to geopolitical uncertainty.
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Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Lengthy negotiations over the weekend between the US and Iran failed to produce a peace agreement.
In response, President Trump announced a full naval blockade of the Strait of Hormuz starting at Monday at 10 a.m. Eastern, which is just about 15 minutes from now. Now, whether it happens or not is uncertain.
Financial markets are down this morning as a result of this weekend's developments after reacting strongly last week to the ceasefire news. So plenty to talk about. Fortunately, we have Jason Draho, head of asset allocation for the Americas with the UBS Chief Investment Office joining us in studio this morning.
Jason, welcome back. Hope you had a nice weekend. I did indeed.
As we were discussing right before, that the weather is turning. It feels like now spring is fully here. So try to stay on the optimistic side of things at this point.
Definitely. That can make all the difference indeed. So Jason, I won't ask you in real time to comment on the state of the blockade.
It's very fluid, but curious to hear about your big picture assessment of the conflict and the risk of escalation versus de-escalation. Well, we did this a week ago and it's a relative two week ago. The news is at least less bad or it's getting less bad.
And if not, maybe even incrementally, a little bit positive. And I think as a result, I think it's maybe reasonable to think that we are past the peak geopolitical risk for this conflict, even though sort of in absolute terms, it still remains relatively high. So what do I base this on?
Well, again, over the past week, we did have the announcement of two week ceasefire. Now it's unclear just how well that's been enforced. There's definitely been reports of military action since then, but that was agreed to.
We did have 21 hours of negotiations between the U.S. and Iran over the weekend. I would point out that this was, I think, the first time such senior officials, we had a vice president from the U.S., senior leaders from Iran meeting in person in 47 years, which I think is not a trivial kind of development. Ultimately, of course, they did not reach the peace deal, as you mentioned.
And then President Trump on Sunday did tweet out that they will begin this blockade of the Strait of Hormuz. But he also began his tweet by saying that most of the points were agreed to. The key sticking point remains on the nuclear facilities and potential development of nuclear capabilities.
So those are, I mean, you can glass half full interpretation, but sort of relatively positive things. There was also just maybe in a more operational aspect, reports over the weekend that additional military support is arriving in the Gulf, I think an additional third aircraft carrier. Mine sweeping sort of capabilities are also arriving and will be deployed in the region, which I would interpret as that the U.S.
Navy is going to attempt, maybe relatively soon, to see if they can remove potential mines, create a military channel perhaps where ships can pass through. So through not as aggressive direct actions with Iran, but just through their own actions, trying to provide a passage for some traffic could increase, which ultimately for the economy, for global financial markets, that is the key thing, is does oil continue to flow through even if there's still some kinetic military action taking place. So all told, again, I'd say risks are still high, but the path does look like it's more towards de-escalation at this point in time and sort of rather than escalation.
And therefore, even though the supply of oil going through the strait is still very limited, it can't get much worse than that. But the expectations that perhaps later by April or May, that could start to increase. I think there's still good reasons to think that is on track despite the blockade efforts.
So more to come perhaps this week. We'll continue to follow this. So I do want to point out, Jason, in your most recent blog, title is The Next Chapter, that investors would be happy to turn the page on this geopolitical crisis as the primary market driver and that market pricing suggests that they are in fact doing so.
Why do you say that? Well, I think it's not just investors. I think most people would want this to completely de-escalate for this to be over.
In terms of the markets, and the reason why I say this is if you actually look across financial markets, equity, bond, interest rates, or currencies, it also suggests over the past two weeks and accelerating last week that there is a pricing out of what I would say inflation risks and growth tail risks. How do I say that? Well, if we look at the S&P 100, it has gone up over the past couple of weeks.
It's now only 2.3% below its all-time high. It also closed on Friday above 6,800. And really, for three months prior to the pandemic, pretty much from late Thanksgiving through the end of February, the S&P traded in a pre-debt range of 6,800 to 7,000, never really going above, but also not really going below.
So to some extent, the equity markets are saying, well, we're kind of back to where we were at the end of February. Then you go to the bond market. Yields are certainly higher than they were six weeks ago, but the 10-year did decline from close to 4.5% to around 4.25%.
It's back up a little bit this morning. Same thing on the two-year part of the curve. It rose a lot and it's also pulled back.
If I look at the 10-year yield at about 4.3%, it is roughly in the range that we've had for over a year now of between 4% and 4.5%, which oscillated based off of shifting kind of economic data, other considerations. In the middle, we'll suggest again, we're kind of back to sort of a normal level over the past year from the rates markets. We go to corporate bond spreads, investment grade and high yield corporate bond spreads in the U.S. at the benchmark level are actually lower now than they were before the pandemic.
Not the pandemic, but the crisis began. So across kiosk classes, we're seeing kind of this taking out of the risk. The U.S. dollar, which had been a safe haven, actually fell a decent amount last week.
EM currencies that tend to be more economically sensitive were rallying quite a bit. So all of this is consistent with the markets kind of pricing out this risk. And maybe they're a little bit ahead of what the situation entails.
That's kind of the whole turning the page. They're eager to turn the page. But the market pricing suggests they are kind of moving on to a certain amount.
And if we didn't look at just what's happened over the past six weeks and compare it to other geopolitical events over the past 30, 40, 50 years, on average, the S&P 500 fell I think something like 7% or 8% in the 5% range. It took three to four weeks to reach the bottom and then start to recover. So six months after the risk event, geopolitical risk event began, the S&P was ultimately higher on average.
So if you map out how the S&P is tracked this time, it looks kind of similar. So it took about three to four weeks to the bottom. It's kind of recovering and six months later, which would take us to the end of August, we think ultimately the S&P will be higher than where it was began.
So this looks like ultimately so far other situations where we had these geopolitical events. So it's important to keep this market pricing in context. Now if the markets are returning to their levels of late February, then the question becomes where do they go from here and what will drive them?
What do you think? So just think about where can we begin the year. The narrative in the marketplace is we'd have a running hot economy with strong growth in the first half, inflation is still elevated, policy makers being supportive of growth.
We moved into February and the focus really shifted to AI as a disruptive force, not only within the tech sector but other business models that was a very prominent theme driving things. A consequence of that, disruption to software kind of raised problems and issues in private credit because a lot of private credit lending had gone to software companies. Suddenly these companies, you wonder about their long-term viability and raised questions about private credit.
So I think what will happen to some extent, certainly in the coming weeks, will be a refocus on kind of those drivers but also the earnings season because this morning already the first quarter earnings season began when Goldman Sachs reported. So these are the things that the markets will have at least something else to focus on. From an earnings perspective, we think the outlook for at least Q1 is positive.
I think the bottom-up consensus is about 14% earnings growth this year versus last year. We're looking at 17% which is kind of the 14 plus, a typical 3% on average beat. Guidance going into the earnings season has been kind of positive meaning oftentimes companies use the couple of months prior to sort of downgrade or sort of guide and it's lower than ultimately kind of lower the bar than beat it.
That has not been the case this time. Earnings expectations for the full year for the S&P 500 is 11% growth. So everything so far is sort of indicative that we're on track for that and that's a key driver for ultimately kind of for equity outlook this year.
The guidance that companies can provide to the extent they can provide guidance at a time when there's still a lot of uncertainty, that would be kind of helpful at least if they kind of reiterate. If we look at the specific sectors like banks reporting a lot this week and kind of early in the season, it's going to be an indication of like how their business has been impacted and given that they're reporting only through Q1 but we are now going to be roughly mid-April, they can give some guidance of where they see some trends going. But also perhaps important to their private credit concerns is that they may also provide more transparency and guidance in terms of what is their actual exposure, how at risk are they and our expectations are that they're not that exposed.
The systemic risk concerns regarding private credit will be kind of further kind of tamped down. The banks will sort of illustrate like we are not significantly exposed, which not a major market driver but certainly kind of alleviates some of those concerns. The other aspect throughout the earnings season will be a lot of focus on like AI disruption, whether it's in the tech space or let's call it tech plus because you have a number of mag seven companies that are in consumer discretionary and the comm services.
So there will be a lot of focus there. So even before earnings season starts, equity markets were up last week on the ceasefire news as the POS up over 3%. The mag seven were up 5% last week, so leading the way.
The SOX Semiconductor Index soared 13.5% last week. For multiple reasons, some of it is just rising agentic related token demands, basically signs that demand for compute continues to go up and exceed expectations. We're seeing investors sort of re-engage with the AI kind of secular theme after concerns back in April or sort of back in February.
And then there was also what you could say maybe spooked some people was Anthropic introduced to this mythos, which raised concerns about security and they actually only kind of released it to a handful of tech companies also, but in the banks for security reasons, you test it out. But the metrics on the application itself were strong. So all these things again suggest the developments in AI continue to be constructive.
The investments continue to be positive. There will be certainly disruption risk, but I think the story from an earnings perspective is this is a key driver for earnings this year. It's less tied to the macro developments and as the season kind of plays, I could kind of reinforce that narrative overall.
So that's what will happen in the next three, four weeks. Beyond that, what the markets will also focus on is ultimately economic data. Because it's sort of slower moving, it's monthly data, we've already got the March data, which a lot of it you could say wasn't going to be impacted that much by oil prices as we move into early May, we get the April data where you can start to see perhaps is the consumer being impacted, where is inflation going?
And of course, if the ceasefire were to hold, if oil will increase through the Strait of Hormuz, near-term economic weakness for the next couple of months, ultimately investors will kind of look through that thinking, well, once we get through this, inflation will come lower and growth can sort of resume a steady trend. And the inflation data from Friday, not great, but largely expected. The headline was as expected.
The core inflation, a little bit below expectations. So absent everything else, you almost think, well, that's good news for the Fed because it's the key is the core. The headline number, ultimately the Fed would sort of believe that this is temporary, that it's a one-time sort of price shock that a year from now that's going to roll off.
So the underlying trend of core is not being impacted, that's the positive takeaway from that data point. So with these macro and geopolitical considerations in mind, Jason, still a fair amount of uncertainty out there in terms of what to do from a positioning standpoint. What are CIO's key recommendations at the moment?
Well, we do have a constructive and medium-term outlook on the markets. It's based on ultimately the macro conditions getting better, growth around 2% trend level. Yes, inflation will go higher, but again, the core numbers we think will generally trend lower, allowing the Fed, before we run into cut rates, we're assuming September and December.
The risk is that could be a little bit later. I mentioned the earnings data with 11% earnings growth expected this year. If you just get that without any price in multiple expansion, that would sort of justify our price target of $7,500 by December, which implies a little more than 10% upside between now and year-end.
So constructive there for U.S. equities. Near-term, obviously a lot of volatility and uncertainty, things could pull back a bit. I'd say investor positioning that was shifting towards de-risking and hedging for much of March into early April, that started to pivot a little bit late last week.
But overall, I'd say investor positioning from the kind of key metrics that we would look at, we'd say, if anything, it's now shifted to be a potential tailwind. So if the markets start to move higher, systematic strategy, other things like that could be sort of a tailwind for equity markets to move higher. For other asset classes, I mentioned the 10-year sort of in the middle of the range.
So rather than take a lot of interest rate risk at this time, we still kind of recommend more of the front end, kind of shorter duration, going up in quality still because those corporate spreads are tighter than they were pre-conflict and even then, you weren't getting necessarily compensated a whole lot. So rather than taking a lot of risk and credit, we think equities offer the better reward. And then commodities, constructive gold kind of constructed.
And if rates do decline as we expect, gold should also kind of get a tailwind there as well. Well, Jason, very productive as always, starting the week with some insights into what took place over the weekend, what that means for markets, and as always, appreciate the guidance when it comes to navigating this market environment and positioning your portfolio. So appreciate the insights today, Jason, and we'll catch up again next Monday.
You're welcome. I enjoy the beautiful spring weather this week. Likewise.
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