UBS On-Air: Paul Donovan Daily Audio 'Ceasing the ceasefire?'
The current geopolitical tension stemming from the U.S.-Iran exchange of fire has elicited a notably muted market response, indicating that investors are not overly concerned with immediate ramifications. Per the full note from UBS, this appears to reflect a prioritization of Iranian threats over the optimistic rhetoric from the U.S. administration. Despite fears regarding regional instability, oil prices remain stable well below levels that would significantly suppress global demand as they are not close to the estimated thresholds required for a 7% reduction. Current asset pricing suggests that while inflationary pressures are on the rise, maintained consumer spending is expected to absorb these costs without drastically affecting corporate margins.
What the desk is arguing
The FX desk is contending that the financial markets are primarily pricing in the geopolitical risks related to the U.S.-Iran situation, yet remain cautiously optimistic about growth. Per the full note from UBS, while ongoing unrest in the Strait of Hormuz is acknowledged, the expected escalation appears already imbued into market valuations.
The desk underscores that oil price stability, as noted by UBS, is critical; current speculative levels lack the urgency for a demand contraction given that they stand well below the $80 per barrel threshold required for a significant demand pullback. Investors' expectations of costs being passed through to consumers further embolden this view.
Where it sits in our coverage
Our current consensus target for USD/CAD is 1.075, with a range from 1.04 to 1.12. We note the following firms and their respective March 2026 targets: - JPMorgan: 1.10 - BofA: 1.04
This view aligns closely with JPMorgan's optimistic target, falling near the upper end of consensus, while diverging from the more cautious stance of BofA, who positions far lower at 1.04.
How other firms see it
Several firms, including Goldman Sachs and Deutsche Bank, appear aligned with the positive outlook on oil dynamics and their impact on the CAD's valuation. Conversely, BofA and Citi have highlighted potential downside risks based on slower global recovery narratives. In particular, keep an eye on the USD/CAD outlook as correlated with oil price trends and BoC monetary policy signals.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Geopolitical tensions are already priced into the market; minimal impact on oil prices.
- 02Investors expect costs to be absorbed by consumers, maintaining corporate margins.
- 03Current oil prices are well below levels that would significantly distort demand.
- 04Expectations of ongoing economic recovery remain intact despite geopolitical risks.
Market implications
Focus on the USD/CAD exchange rate as it likely reflects the evolving narrative around oil prices and U.S.-Iran tensions. Should crude oil prices remain stable, anticipate the CAD to fortify against the USD.
Risks to this view
A substantial rise in oil prices beyond current market expectations could exacerbate inflationary pressures and alter consumer spending habits, forcing a reevaluation of corporate earnings growth and, consequently, market sentiment. Increased military actions or escalatory diplomatic breakdowns may also shift this calculus dramatically.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Tuesday the 5th of May.
Markets have had a fairly muted response to the exchange of fire between Iran and the United States. US President Trump's positive assertions over the course of the weekend had been largely ignored by investors on Monday. Credibility was given instead to the Iranian threats.
So the idea of ongoing problems in the Strait of Hormuz was already more or less in the price. We're still not close to the level of oil price required to slow global demand by 7% or so, which is what is estimated to be required once oil reserves have been exhausted. So within that pessimism on the current situation, there is still a residual optimistic bias built into asset pricing.
Various politicians around the world have been proposing attempts to mitigate the damage to consumers with reduced energy taxes or price controls. That of course will not help. Supply is down and demand needs to come down to match that eventually.
Artificially suppressing prices does not reduce demand, it will just create pressures for even higher crude oil prices. Higher oil prices need not create concerns over earnings growth in the near term because there is an expectation of costs being passed through to the end consumer. We saw exactly this with US tariffs, a different sort of supply shock, but one that is helpful as a guide to pricing power and the likely responses of companies.
Margins are likely to be maintained as long as consumers are able to scale back savings rates in order to pay for the higher prices. This is not profit-led inflation. Margins shouldn't be expanding in this situation.
It's simply relative pricing power. When consumers in developed economies began the year with pretty good household finances and fairly large amounts of saving. The fact that rising inflation might be met out of consumers' savings helps to account for some of the European Central Bank commentary yesterday with a suggestion that inflation might be more affected by the oil price move than the growth rate will be.
The range of comments was fairly predictable. Nagel offered a Pavlovian, we should hike response while Villaroy, equally predictably, urged caution in the absence of a critical mass of data. This is the key point.
If second round inflation effects are to determine whether interest rate increases are required, it is still far too soon for evidence of profit-led inflation or, less likely, a wage price spiral to emerge. In the US, Federal Reserve President Williams said that rates will have to go down eventually and that higher inflation now was simply postponing that. Those remarks suggest a belief that second round effects will be contained.
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