UBS On-Air: Paul Donovan Daily Audio 'Another (downward) inflation surprise'
The desk highlights the implications of China's recent consumer and producer price inflation data, which undershot expectations, indicating a widening trend of disinflation not just in China but globally. Per the full note from UBS, these weaker numbers signal a potential shift in inflation expectations, as reflected in the commentary by Chief Economist Paul Donovan. With the US Federal Reserve remaining vigilant but somewhat restrained in response to these patterns, the interplay between labor market strength and inflation may influence monetary policy decisions. The backdrop of weak inflation data from multiple economies suggests that traders should stay alert for adjustments in market positioning before upcoming economic reports.
What the desk is arguing
The desk contends that China's weaker-than-expected inflation figures are part of a broader trend that may misguide market expectations regarding global inflation. Per the full note from UBS, the disconnect between China's domestic prices and both export prices and global inflation complicates the interpretation of this data. Furthermore, sustained downward surprises on inflation suggest that the consensus around persistent inflation risks may be overestimated, a sentiment echoed by UBS.
The July consumer and producer price indices in China were significantly below forecasts, driven primarily by declines in energy and tourism services—two sectors not typically associated with China's export profile. Donovan points out that the frequent underperformance of inflation data across various economies may indicate a reframing of economic expectations, cautioning against over-reliance on specific monthly statistics given their volatility.
The alternative view—that stronger inflation might persist—seems less compelling in light of recent data suggesting that supply constraints could be easing, thus promoting a more balanced perspective on price pressures globally. This inversion of expectations could set the stage for notable shifts in monetary policy across major economies.
Where it sits in our coverage
Currently, our consensus target for EUR/USD stands at 1.075, with a range from 1.04 to 1.12. Standing aligned with this view, jpmorgan has set a target of 1.10 for March 2026, while bofa holds a contrary position with a lower target of 1.04 for the same tenor.
This reflects a somewhat cautious consensus within the FX space, with our desk's interpretation leaning toward the more dovish end of the spectrum, suggesting that inflation fears may be overstated relative to prevailing economic conditions.
How other firms see it
Among aligned firms, jpmorgan and others share a view that inflation risks are less pronounced, advocating for a tempered approach to trading strategies based on the prevailing data. In contrast, bofa remains skeptical of this disinflation narrative, marking a clear divergence in expectations.
Traders should closely monitor the USD/CNY relationship, as any shifts in Chinese inflation are likely to ripple through global markets, impacting sentiments especially in the export-driven economy of China. Additionally, central bank communications from the Federal Reserve will be critical in shaping the outlook for inflation and its discontents moving forward.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01China's July inflation data surprised to the downside, signaling potential changes in global inflation expectations.
- 02Weakening prices in energy and tourism are highlighting broader disinflation trends across multiple economies.
- 03Market positioning may need recalibration based on this evolving disinflation narrative.
- 04The USD/CNY and other export currencies could see increased volatility as traders reassess risks.
Market implications
Watch for any significant movements in the USD/CNY pair, as sustained weakness in Chinese inflation could trigger shifts in investor sentiment and positioning. Upcoming US economic reports may either reinforce or challenge the ongoing narrative of easing inflationary pressures.
Risks to this view
A sudden spike in inflation data or unexpected economic resilience in the US could negate the current disinflation thesis, prompting aggressive Fed policy adjustments and a resultant strengthening of the dollar against its peers.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Monday the 10th of August. China's consumer and producer price inflation data released over the weekend was weaker than had been expected.
Neither of these numbers have much relevance at a global level. The relationship between China's domestic inflation rate and export prices is weak and the relationship between China's export prices and the consumer price of Chinese imports in other countries is also fairly weak. Weaker prices in oil and tourism services were behind the surprise and these are not obvious exports for China.
However, this is another economy where inflation data has surprised to the downside in the recent past. The thing is becoming something of a trend. There are no dramatic disinflation forces and of course the repeated downside surprises may say as much about the bias of the economic consensus as it does about the actual data.
But it might be the case that the unusual three waves of inflation that elevated prices in 2022 are distorting expectations and economic models to modestly overweight inflation risks in the midst of a more conventional supply shock today. The US Federal Reserve is supposed to focus on unemployment and inflation, although in the confusion of Walsh's non-communication, the balance between those two is not necessarily certain. The labour market data from the States on Friday was weak, but not weak in a way that would seem to seriously threaten US economic activity.
Consumers have, after all, continued to spend money and labour market concerns do not appear to be affecting the will to revel in the shopping mall. The noticeably large revisions to previous month's data are also a reminder not to put too much faith into a single statistic. The Fed is unlikely to be doing that, although of course numbers like this will be seized upon for political point scoring exercises.
The trend of average hourly earnings moderating remains in evidence and that is perhaps more significant, with recent employment weakness occurring in part in lower paid sectors like leisure and hospitality. Fewer low paid workers should raise the average earnings rate, all things being equal. This does rather defy suggestions of inflation second round effects in the form of a wage price spiral.
This is all a prelude to Wednesday's inflation data. It's worth remembering that a very sizeable majority of market economists expect the Fed to be on hold with interest rates this year and to reduce interest rates next year. It is bond investors who are pricing in rate increases, not economists.
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