UBS On-Air: Paul Donovan Daily Audio 'Can US inflation be hedged? '
The desk posits that the upcoming US inflation data will reveal significant impacts from recent trade tariffs, indicating subtle underlying inflation pressures. Per the full note from UBS, Paul Donovan remarks that as these tariffs manifest—a 10% tariff equivalent potentially raising consumer prices by around 4%—the broader implications for US consumer inflation will become clearer. This inflationary environment, however, may prompt diverging strategies among traders as they look for hedges. Our current consensus places targets within the range of USD/CAD at 1.075, supporting ongoing analytical frameworks around inflation protection strategies.
What the desk is arguing
The desk argues that the key takeaway from the forthcoming July consumer price inflation report is the impact of recently implemented trade taxes on inflation metrics. As highlighted in the UBS commentary, these tariffs are expected to seep into consumer pricing but may not result in the broad inflationary alarm that markets perceive—particularly when considering the nature of the consumer price index.
The anticipated increase in inflation may be minuscule, contrary to broader fears, with the desk emphasizing that the quality of inflation data may not support strong reactions. The relationship between equipment prices and overall living costs indicates that consumer perceptions may vary significantly, affecting trading strategies in the FX space.
Where it sits in our coverage
Our current consensus targets USD/CAD at 1.075 with a range of 1.04 to 1.12, contrasting with the targets set by the following firms: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk's position aligns at the upper end of our coverage spectrum, indicating a slight bullish bias relative to bofa's stance but remains modest compared to jpmorgan's forecast.
How other firms see it
Firms aligned with our perspective, such as jpmorgan, suggest an outlook supportive of stable inflation metrics, while bofa holds a contrary view, anticipating sharper declines in USD/CAD, reflecting more significant vulnerabilities.
Key determinants to observe include US consumer sentiment trends and any adjustments in the Fed's policy stance as inflation data evolves. Positions in USD/JPY and EUR/USD could also reflect broader shifts in inflation expectations and impact currency trajectories.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01US inflation data is likely to reflect the impact of trade tariffs, with potential increases in consumer prices driven by these factors.
- 02The quality of inflation data is under scrutiny, with concerns that it may not be as robust as prior metrics.
- 03FX trading strategies may be influenced by differing inflation expectations, with ongoing assessments necessary for informed positioning.
- 04Trader focus should include expectations around the Fed's response to evolving inflation data.
Market implications
Watch for any notable shifts in the upcoming consumer price index data release. Levels around 1.075 for USD/CAD are critical, as they will inform traders' strategies in response to evolving inflation scenarios.
Risks to this view
If the inflation data significantly deviates from expectations, particularly lower than anticipated inflationary pressure, it could lead to a rapid reassessment of FX positions, undermining the current bullish stance on USD/CAD.
Good morning, this is Paul Donovan, Chief Economist at GBS Global Wealth Management. It's 7 o'clock in the morning London time on Tuesday the 12th of August. Today we get the release of US July consumer price inflation.
The consensus is for a small increase in the rate of inflation as more and more of the April trade taxes start to seep into the consumer's shopping basket. Remember that each 10% tariff equates to around about a 4% consumer price increase. And of course the majority of the consumer price inflation is made up of services that are far less affected by trade taxes.
It will be the details of today's data that will allow economists to start to assess the extent of the trade tax damage to US living standards. To some extent trade taxes create an absence of disinflation rather than necessarily stronger inflation. US consumers may be less aware of this inflation than they were of the inflation that existed under US President Biden.
This is because US President Trump's inflation episode is more focused on durable goods, not high frequency purchases like food, which are more likely to be domestically produced. People are generally less conscious of price increases for lower frequency purchases. It's also worth reflecting that today's data is of lower quality than the consumer price inflation data that was released just six months ago.
Former presidential adviser Musk's antics with chainsaws, combined with several years of budget cuts generally, mean that fewer and fewer price points are being used to estimate a more and more complex concept. Of course, this does not mean that political bias is yet coming into the data. It just means that the data is less reliable for other reasons.
Of course, many investors do not like inflation and often wish to hedge against it. However, the options for US citizens hedging against inflation are less obvious now. Some people regard gold as an inflation hedge, leaving aside whether that is remotely true.
Buyers of physical gold will have seen their spending power slashed by 10% unless trade taxes are reversed in the States. Buying inflation protected bonds issued by the US government might seem a good idea until one realizes that the return on these is tied to whatever the Bureau of Labor Statistics says inflation is. While that may have been more or less accurate to date, not only is the quality declining now, but Trump's nominee to head the Bureau of Labor Statistics is likely to raise concerns about the independence of data in the future.
If the Bureau of Labor Statistics fiddles the figures, to use a technical term, under a politicized leadership, then bondholders will not, in fact, be protected against actual inflation, only against the inflation of the fantasy world occupied by some politicians. Trump has retreated from the deadline to aggressively tax US consumers of product from China for another 90 days. Higher trade taxes were scheduled to take place today.
This retreat was expected by markets, obviously. UK labour market data was somewhat stronger than expected. The three-month payrolls figure was stronger, and there were upward revisions to earlier employment numbers.
Real wages continue to grow. That offers support to consumer spending, visible in the British Retail Consortium's retail sales data. Job vacancy numbers declined.
This refers to externally advertised vacancies, and the trend to lower vacancy numbers does reflect a shift to a more normal labour market churn post-pandemic. The question is whether that is now extending into a period of reduced willingness to hire new workers. Rising workforce participation rates are something of an offset to that narrative.
That's all for today. Have a good day. This material has been prepared and published by the Global Wealth Management Business of UBS Switzerland AG, regulated by FINMA in Switzerland.
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