UBS On-Air: Paul Donovan Daily Audio 'Capping inflation'
The updated commentary from UBS highlights the connectedness of bond market movements, geopolitical tension, and inflation expectations. As investors react to the ongoing war in the Middle East, there is speculation that pressure on bond yields may prompt a policy response from the U.S. administration similar to that observed during tariff negotiations. Per the full note source, while markets are anxious about rising inflation driven by fuel and food prices, the likelihood of a meaningful policy shift remains uncertain due to the complex geopolitics involved. This context holds potential implications for currency pairs sensitive to U.S. fiscal and monetary policy shifts.
What the desk is arguing
The UBS commentary underscores the fragility of bond markets amidst geopolitical tensions, particularly regarding the Iran conflict and its inflationary repercussions. Investors are hopeful that sustained distress in the bond market might instigate a shift in U.S. policy, akin to past tariff negotiations. This expectation is particularly notable as inflation perceptions are heavily influenced by essential goods prices, notably food and fuel.
Donovan points to a significant political weight carried by fuel prices, with recent spikes at the pump influencing U.S. inflation perceptions. The commentary notes that food inflation is a growing concern in both the U.S. and the U.K., where the government is pushing for voluntary price caps amid soaring prices, which has resulted in supermarket pushback due to margin pressures. This pervasive inflationary sentiment could dampen consumer spending and impact economic stability moving forward.
Where it sits in our coverage
Our consensus target for the EUR/USD currently stands at 1.075, with a range between 1.04 and 1.12. Notable targets include: - jpmorgan: 1.10 by Mar26 - bofa: 1.04 by Mar26
This perspective aligns with our principal forecast, which maintains a cautious outlook amid rising inflation fears. In contrast, bofa's lower bound forecast suggests a more bearish stance on the euro's resilience against dollar strength.
How other firms see it
Firms that align with this bullish outlook include jpmorgan, reflecting confidence in the euro's ability to navigate current inflationary pressures effectively. On the contrary, bofa presents a more cautious stance, potentially foreseeing greater dollar strength against the euro.
The implication of these dynamics can be observed in the EUR/USD trajectory, closely monitoring both the U.S. Federal Reserve's monetary policy responses and inflation indicators to gauge market sentiment moving forward.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Geopolitical tension is driving bond market volatility and inflation concerns.
- 02Investor sentiment may influence U.S. policy shifts, especially on inflation.
- 03Rising fuel and food prices are critical concerns for both the U.S. and U.K.
- 04Supermarkets' resistance to regulatory price caps highlights margin pressures.
Market implications
Watch for critical levels around 1.075 in the EUR/USD pair, which could indicate a shift in sentiment based on inflation perceptions and U.S. policy responses. Ongoing inflation data releases will be crucial for market positioning.
Risks to this view
A significant escalation in Middle Eastern conflict or an unexpected policy shift from the Federal Reserve could reverse current market dynamics, leading to a stronger dollar and broader risks for the euro. Additionally, if food and fuel prices stabilize or decline, investor sentiment might shift away from inflation concerns.
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 20th of May. Bond yields have continued to move up, a shift that has started to impact equity markets as well.
There is a hope amongst investors that sufficient pain in the bond markets might attract the attention of the US administration and push towards an end of the war. While this worked with the imposition of tariffs last year, tariffs were something that were, at the time, directly under the control of the US President and could be reversed on a whim. The Middle East is a little more complex than that and investors have shown less and less willingness to react to US President Trump's announcements on the war unless there is independent verification or a reaction from the Iranian government.
Comments on the war from China's President Xi, currently meeting with Russian President Putin, might be seen more favourably by investors as China may have some influence with Iran. Inflation perception is driven largely by high frequency purchases that people make. That means that food and fuel prices have disproportionate political weight, which is why the soaring price of gasoline is so important in the United States.
In the United Kingdom, petrol prices also matter, but less so, as people do walk or have the option of urban public transport. Food prices in the UK, however, are a political focus. Media reports suggest that the UK government has asked supermarkets to put in place voluntary price caps on key food items like bread and milk in exchange for regulatory change.
Supermarkets have responded with hostility and there have been predictable comments about the tightness of supermarket profit margins in the UK. In March, a pint of milk sold for 74 pence in the UK, 54 pence of which was mark-up after the milk leaves the farm. As a percentage of the final price, the 73% mark-up is the highest in a decade and historically is exceptionally high.
Today's UK inflation data did show slowing consumer price inflation. Some slowdown was expected, as electricity prices have long been subject to an involuntary price cap. This price cap fell because the reference period for calculating the cap predated the war and so has not been affected by gas price shifts.
Heating oil prices, which are not capped, but which are also a fairly small part of the basket of goods, did increase to reflect war costs. There were some calendar effects, with the timing of Easter helping to lower some prices, especially around leisure travel. Bank of England Governor Bailey and other members of the Monetary Policy Committee will be testifying to Parliament today.
The questions that politicians tend to ask at these sessions do not, as a rule, warrant much attention by financial markets. But the prepared remarks do help shape expectations around future policy. We get the minutes of the April FOMC meeting of the US Federal Reserve.
This was a very divided meeting, of course, and the strength of opinion expressed does matter as the Fed awaits the final paperwork for putting Fed Chair nominee Walsh in place. It is presumed by the next meeting. The depth of division matters because Walsh's reputation is likely to make leading from the front more difficult.
It is unlikely that members of the Fed will simply fall into line with Walsh's view, and the greater the conviction, the more problems Walsh will have in implementing a desired policy. That's all for today. Have a good day.
It's subsidiaries, or affiliates, collectively referred to as UBS. In the USA, UBS Financial Services Inc. is a subsidiary of UBS AG and a member of FINRA-SIPC. The investment views have been prepared in accordance with legal requirements designed to promote the independence of investment research.
This material is for your information only, and it is not intended as an offer or a solicitation of an offer to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal investment recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. This material may not be reproduced or copies circulated without prior authority of UBS.
Please visit www.ubs.com forward slash CIO hyphen disclaimer to read the full legal disclaimer applicable to this material.
Sources & References
How we cover this story