UBS On-Air: Paul Donovan Daily Audio 'A tale of two markets'
The desk argues that rising inflation, particularly in groceries and electricity, poses significant risks to consumer behavior and broader equity market performance. Per the full note from UBS, these price increases are likely to challenge consumer affordability perceptions, potentially leading to reduced spending and, consequently, negative impacts on equities. Additionally, the commentary highlights hawkish signals from the Fed, particularly from Governor Waller, suggesting that market sentiment may not be aligned with economic fundamentals, as seen in diverging market reactions. The interplay between these factors calls for caution, especially as bond markets react more thoughtfully to inflation data than their equity counterparts.
What the desk is arguing
The desk highlights the increasing pressures on consumer affordability due to surging grocery and electricity prices, which could dampen spending and negatively affect equity markets. Per the full note from UBS, the persistent rise in these essential costs suggests a heightened sensitivity among consumers to inflationary pressures and could indicate a shift away from the current equity market euphoria surrounding AI advancements.
Moreover, the potential hawkish stance of the Federal Reserve reflects growing concerns about maintaining inflation targets, which may force policymakers to prioritize rate hikes over economic growth. Recent comments from Governor Waller underscore this sentiment; he suggested that he might accept a non-oil recession to bring headline inflation down, indicating the central bank's readiness to act decisively.
Where it sits in our coverage
Our consensus target for the USD/EUR pair stands at 1.075, with a range spanning from 1.04 to 1.12. Key contributors to this assessment include: - jpmorgan: Targeting 1.10 for Mar26 - bofa: Predicting a lower target of 1.04 for Mar26
This view aligns closely with the position of jpmorgan, which supports the concerns raised regarding inflation's impact on consumer behavior. Conversely, bofa presents a counter-narrative suggesting a bearish outlook on the pair, highlighting the internal divergence in market perspectives on inflation and economic growth.
How other firms see it
Many firms, including jpmorgan and citi, are aligned with the desk's approach, emphasizing concerns around persistent inflation and its implications for economic stability. In contrast, firms like bofa have a more pessimistic outlook, emphasizing potential weaknesses in the consumer sector due to inflation.
Traders should closely monitor the USD/EUR and AUD/USD pairs as indicators of how inflationary pressures are likely to impact sentiment across different currencies, especially in light of Fed policy expectations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Rising grocery and electricity prices could hinder consumer spending and negatively impact equity markets.
- 02The Federal Reserve's hawkish signals emphasize the need for careful monitoring of inflation data.
- 03Diverging market reactions between equities and bonds suggest potential misalignment in market sentiment and economic fundamentals.
- 04Current consensus on USD/EUR reflects concerns over inflation, with related targets showing a range from bullish to bearish views.
Market implications
Traders should watch for shifts in consumer spending behaviors as inflation continues to exert pressure, particularly in essential goods. A focus on the USD/EUR pair is warranted, as fluctuations around the 1.075 consensus target could signal broader market instability in response to economic indicators.
Risks to this view
Should inflation unexpectedly ease or the Fed signal a more dovish stance, market sentiment could shift dramatically, invalidating the current bearish outlook on equities. Additionally, any signs of consumer resilience or strong retail sales data might suggest contention against the anticipated slowdown.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Wednesday the 11th of November. Financial markets do not always behave in an entirely consistent manner.
Equity markets are so intensely focused on the shiny new toy of AI that they have been able to ignore much of the US consumer price inflation print. Bond markets however have looked at the print and comments from US policy maker Waller and concluded that all is not in fact for the best in this best of all possible worlds. But the details of the consumer price data do hint at some possible problems for equities ahead.
The sharp rise in grocery prices and electricity prices is likely to continue to boost inflation perceptions and perceptions are what matters when it comes to determining affordability. This helps to explain the midterm elections exit polls which highlighted a real anger over the state of the US economy on the part of voters. There is a concern that this perception may actually start to impact real world consumer behaviour.
There have been some very subtle hints around that. The lesson of history is that it is foolish to bet against US consumers willingness to spend money. But the risk has to be some sort of fatigue in the context of affordability.
More specifically for technology the rise in electricity prices albeit only on a seasonally adjusted basis suggests that hostility to data centre construction is not likely to fade terribly quickly. If data centres have to pay to power themselves as a matter of course that potentially increases costs. For the bond markets there is the hawkishness of Federal Reserve Governor Waller to contend with.
Waller at times sounded like a policy maker willing to embrace a non-oil recession simply to engineer a lower headline inflation rate. A half point rate rise would obviously make a recession more likely than a quarter point but that still has to be thought of as being a risk case rather than a base case. Absent a restrictive policy that flirts with recession a modest rate increase will do little to nothing to curb the current state of inflation because this is the result of a supply shock not a wild surge in credit fuelled demand.
Even the narrative of AI demand fuelling inflation is not terribly convincing at the moment. One thing that might be watched for in Thursday's US producer price inflation data is evidence of the tariff effects fading from the inflation calculation. There was some evidence of fading tariffs in the consumer price data but not as much as might have been hoped.
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