UBS On-Air: Paul Donovan Daily Audio 'Doing nothing in an uncertain world'
Lead — As the market gears up for the Federal Reserve's upcoming policy decision, prevailing sentiment suggests no rate change will occur. However, uncertainties loom regarding the broader implications of trade policies and their implications for inflation and employment. Per the full note from UBS, while the preliminary employment data showcased some strength, certain sectors like trucking are at risk due to slowing import volumes. This backdrop amplifies the Fed's existing challenges as it seeks to navigate the complexities that tariffs present to economic growth and price stability.
What the desk is arguing
The desk posits that the Fed's upcoming policy decision may be influenced more by external trade dynamics than by domestic employment metrics. Per the full note from UBS, while April's employment figures showed modest growth, rising employment in sectors like trucking signals underlying vulnerabilities due to anticipated declines in import volumes.
Evidence of transitory characteristics in employment reports underscores the market's cautious stance, especially considering trends in tariffs exacerbating inflationary pressures before they impact growth. For instance, data indicates that one-third of China's exports are being rerouted to circumvent tariffs, complicating the Fed's decision-making process.
Where it sits in our coverage
Our current consensus target for USD/CAD is 1.075, reflecting a range of potential outcomes influenced by employment data and trade actions. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk's perspective aligns closely with jpmorgan, indicating a significant focus on the interplays between employment dynamics and trade tariffs, placing us at the upper bound of the consensus range.
How other firms see it
Firms aligned with this perspective, such as jpmorgan, highlight the ongoing implications of domestic employment and trade while viewing potential tariff impacts critically. Conversely, bofa holds a more pessimistic view on the scale of impact from trade policies, suggesting a lower target.
This dynamic is crucial for pairs like USD/CAD which tend to react fiercely to inflation signals and Fed actions, with the upcoming policy decisions poised to induce volatility in currency markets.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Federal Reserve set for a policy meeting with low expectations for rate changes.
- 02April employment data shows growth but with sector vulnerabilities.
- 03Trade tariffs complicate the Fed's inflation outlook.
- 04Market anxiously awaits the implications of forthcoming economic reports.
Market implications
Watch for the Fed's comments on trade and inflation during their announcement, particularly any unexpected shifts in rhetoric that could impact market sentiment. Additionally, monitor USD/CAD for volatility as new economic data emerges.
Risks to this view
A swift reversal in trade policy or unexpected geopolitical tensions could undermine current assessments of employment and inflation. If import volumes recover rapidly, it would necessitate a reevaluation of growth forecasts and potentially push the Fed towards a more hawkish stance.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 2.30 in the morning London time on Monday the 5th of May. Financial markets have the excitement of the US Federal Reserve policy decision on Wednesday of this week.
The market is not looking for a change in interest rates at this meeting, but there's a reasonable degree of uncertainty about what then happens next. Last Friday's US employment report was OK, but the effects of trade taxes are not going to hit growth for some time. It is inflation that will be affected first.
Nonetheless, the details of the employment report did show some characteristics that the Fed must consider to be transitory. Employment in the trucking industry rose, for instance, and that is unlikely to continue as volumes of imports start to slump. Admittedly, there will still be a need to move inventory around from warehouses to retailers.
The Fed does not, at this stage, have a great deal of transparency on the inflation effect of the trade taxes, and in particular the second round effects. There's uncertainty about what the trade taxes will be. Overnight, US President Trump declared a 100% tax on foreign movies on the grounds that Mr Bean is a national security issue.
There is also uncertainty about whether the trade taxes are being collected at all, with reports of careful rerouting of trade from China. One third of China's exports rerouted to avoid US President Trump's first-term taxes. There is uncertainty about how US manufacturers will respond to the taxes as well.
Perhaps most significant, there's uncertainty about how US retailers are going to respond. The Fed could have to take into account attempts to instigate another round of profit-led inflation. Certainly, some of the tariff surcharges that are being applied to retail receipts and posted on social media suggest that more than the cost of the tariff may be being passed on to consumers in some cases, always assuming the social media posts are accurate.
It is just possible that partisan political bias may have extended into social media. There is little in today's data releases to improve either markets or indeed the Federal Reserve's understanding of the state of the economy. Service sector business sentiment polls are a weak source of information in normal circumstances and in the increasingly polarised and indeed sensationalist world that we operate in, these are definitely not normal circumstances.
Any information from the ISM on reported comments of the surveyed companies might be of some interest. These will still be subject to political bias, of course, but do give perhaps a sense of degree of the consequences for businesses of policy uncertainty. That's all for today.
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