UBS Morning audio comment: The Fed – mime versus meme
The desk's current outlook centers around the Federal Reserve's communication strategy, which has been highlighted as ineffective by UBS Chief Economist Paul Donovan. He argues that Fed Chair Warsh's reticence to clarify policy leaves inflation perceptions vulnerable to meme-like influence, complicating the public's understanding of inflation trends. This sentiment is rooted in ongoing supply shocks leading to persistent inflationary pressures, which, while appearing continuous to the public, are actually distinct events each year. As the market awaits forthcoming Federal Reserve commentary, the potential for a more proactive communication stance could materially shift market sentiment moving forward.
What the desk is arguing
The desk frames the issue of inflation communication as a critical challenge for the Federal Reserve. According to Paul Donovan of UBS, Fed Chair Warsh's silence on policy creates a disconnect that allows meme-like inflation narratives to flourish among consumers. In a market rife with ongoing supply shocks, clarity from the Fed is essential to re-align public perception and economic reality as shown in the fourth consecutive inflation event.
Warsh's approach, characterized by high rates as a signaling mechanism rather than genuine policy efficacy, risks misjudging neutral rate levels. If the Fed continues to deliver vague guidance, investors might interpret rate hikes as signs of impending recession rather than mere inflation control. Reports highlight that the U.S. administration's foreign policy signals — particularly concerning oil-producing Gulf nations — could further exacerbate inflation dynamics as energy prices remain sensitive to geopolitical developments.
Where it sits in our coverage
In our current coverage, the consensus target for USD/EUR stands at 1.075, with a range between 1.04 and 1.12. The following firms have published relevant targets: - jpmorgan: 1.10, Mar26 - bofa: 1.04, Mar26
This view aligns with the broader market consensus considering jpmorgan positions on the higher end of the spectrum, while bofa advocates for a more bearish outlook on the pair. Thus, our desk's interpretation aligns closely with prevailing market sentiments, indicating a cautious yet fundamentally supported bullish stance.
How other firms see it
Firms aligned with our perspective include jpmorgan, anticipating strong economic fundamentals supporting the dollar, and citi, which sees inflationary pressures reinforcing the need for a robust rate stance. Conversely, bofa and deutsche offer contrary views, emphasizing the risk of a slowing economy as a cause for potential dollar weakness.
The USD/EUR trajectory will likely reflect these underlying Fed dynamics, especially as central banks like the ECB navigate their inflation confrontations, potentially impacting EUR/USD and GBP/USD outlooks during this volatile period.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed Chair Warsh's muted policy communication increases market uncertainty.
- 02Persistent supply shocks contribute to misaligned inflation perceptions among consumers.
- 03Geopolitical tensions in oil markets are likely to influence inflation and monetary policy narratives.
- 04Investor interpretations of Fed rate hikes are crucial in shaping economic forecasts.
Market implications
Traders should watch for guidance from the Fed in the near term, particularly in relation to inflation projections and potential communication changes. Rate movements could be influenced heavily by geopolitical events impacting oil prices, which are critical for inflation forecasting.
Risks to this view
A significant catalyst for reconsidering this outlook would be clearer communication from the Fed, particularly a pivot toward more aggressive rate cuts if inflation is perceived to be under control. Additionally, easing geopolitical tensions that could stabilize energy prices may also alter market dynamics unexpectedly.
Fed Chair Warsh’s policy is to stay silent about policy. That is ineffective against the meme-like nature of inflation perceptions. View this email in a web browser The Fed – mime versus meme UBS morning audio comment by Paul Donovan Markets are expecting no change in US monetary policy today.
Federal Reserve Chair Warsh’s communication style does not lend itself to offering clarity as to the policy outlook, either. The Fed’s problem is a one-off supply shock inflation episode that they cannot control. Unfortunately, this is the fourth consecutive one-off shock.
To a lay person, that looks like continuous inflation (it is not; what rose in price last year is not what is rising in price this year). Better communication might help change perceptions; consumers are rarely rational when assessing inflation. The Fed’s response is to raise rates to the top of the neutral range to show it is doing something, without actually affecting anything.
The risk is that it misjudges where neutral is, or investors believe the moves herald a repressive policy and a non-oil economy recession. The Wall Street Journal reports the US warned Gulf countries it may pursue a short, intense campaign against Iran after the midterms. Investors are unlikely to focus on the description “short”, and oil prices have risen.
The war has reportedly cost the US USD 47bn already. Israel’s election result appears inconclusive at the moment. This will likely leave Prime Minister Netanyahu in office (and in control of the military) for the time being.
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Sources & References
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