UBS On-Air: Paul Donovan Daily Audio 'Economic impacts'
In the wake of escalating tensions in the Gulf, the desk posits that while the humanitarian fallout is tragic, the direct economic repercussions may be muted unless oil prices sustain a significant increase. Per the full note source, UBS's Paul Donovan points out that the impact of oil price fluctuations on inflation will hinge on their longevity rather than immediate spikes. Since much of the recent inflationary pressures in the U.S. have been tied to perceived costs rather than actual sustained increases, this theme is vital for traders to consider.
What the desk is arguing
The desk frames this as a potential misperception in the market regarding inflationary threats stemming from geopolitical unrest. Donovan emphasizes that while a spike in oil price could stoke inflation fears initially, any substantial inflationary impact depends on prices remaining elevated over time.
Moreover, Donovan highlights that the U.S. economy's decreasing dependency on oil reduces the potential for severe inflation consequences, differing significantly from past crises like the 1973 oil embargo. He notes, "For there to be a real inflation impact, the oil price must be sustained at a notably higher level."
Where it sits in our coverage
The current consensus target for USD/EUR stands at 1.075, with a range extending from 1.04 to 1.12. Notably, firms such as: - JPMorgan: 1.10 by Mar26 - BofA: 1.04 by Mar26
This view aligns closely with jpmorgan, which projects a slight strengthening of USD against the euro. The desk's call is somewhat on the upper bound of this spread, suggesting a cautious outlook on inflation despite geopolitical unrest.
How other firms see it
Firms aligned with the desk's perspective include jpmorgan, emphasizing stability in the USD against the euro. Conversely, bofa expresses caution with a bearish target for the USD, indicating the potential for depreciation if oil price pressures do not manifest as sustained inflation.
Looks to related pairs such as GBP/USD to reflect broader market sentiment. The trajectory of EUR/USD aligns with developments in inflation indicators and central bank policies, offering further insights into market dynamics.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Geopolitical tensions in the Gulf may not result in immediate inflationary pressures unless oil prices rise sustainably.
- 02The U.S. economy's decreased dependency on oil mitigates potential inflation risks compared to past oil crises.
- 03Current market perceptions around inflation could influence consumer behavior, regardless of actual price changes.
- 04Freight costs due to potential shipping disruptions in the Gulf may have limited overall impacts on consumer prices.
Market implications
Traders should watch closely for signs of sustained oil price increases, as this will be pivotal for inflation dynamics. Key levels to monitor would be if Brent crude breaks above $90 per barrel with persistence, which may trigger broader market shifts.
Risks to this view
A reversal in this outlook could occur if the geopolitical situation leads to actual, sustained disruptions in oil supply or if consumer inflation data indicates a marked increase that cannot be ignored.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Monday the 2nd of March. Events in the Gulf are dramatic and the humanitarian cost of war is always horrible.
The economic consequences of current events are, however, less dramatic than the images appearing on smartphones and television screens. Very broadly, there are four considerations. Most obvious is the consequence of a higher oil price, which would be most visible in inflation.
The inflation impact is greater in the United States than elsewhere because of the lower tax rate applied to retail oil sales. However, for there to be a real inflation impact, the oil price must be sustained at a notably higher level. And even then, the world has become progressively less oil dependent in recent years.
This is not 1973. The inflation impact is more likely to be political. The affordability crisis in the States rests in part on inflation perceptions rather than inflation reality.
Until now, rising grocery prices and jumps higher in electricity prices have been partly offset by low or falling gasoline prices. Even if a short-lived jump up in the gasoline price has only a limited inflation consequence, the damage to inflation perceptions is likely to be disproportionate. There is a second potential inflation risk if the conflict in the region again threatens shipping heading towards the Suez Canal.
The Remedia reports that the Houthi movement has said it will resume attacks on Red Sea shipping. This may lead to ships going the long way around and freight costs increasing. However, as with the late 2023 attacks on shipping, the impact on consumer prices from such a move is limited and depends on whether the Houthi act on their threats, of course.
Freight costs are a relatively small part of import prices. Import prices are typically about 40% of consumer prices for imported goods, and imported goods are a small part of the overall consumer price level. The 2023 attacks did not noticeably change macroeconomics, though they may have affected costs for individual companies.
In the longer term, there are two further considerations. The first is the cost to the United States of this war. US President Trump indicated attacks could go on for four or five weeks, and there are already reports of a need to urgently replenish weapons stockpiles.
That potentially adds to the fiscal deficit. It's not likely to be a huge increase in the near term, but it may well be noticeable, coming alongside the presumed rebate of illegal tariffs. For the region, the fact that other Gulf countries have experienced missile and drone attacks is important.
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