UBS On-Air: Paul Donovan Daily Audio 'Hints of hosiery'
The current outlook indicates potential hawkish remarks from Fed Chair Warsh amidst ongoing pressures from the administration, as articulated by UBS's Paul Donovan. Per the full note, markets will scrutinize Warsh's comments for signs of political influence on monetary policy, which could yield volatility and alter the cost of capital. Observers should be particularly wary of any unease that arises should Warsh strive to assert independence, implying a higher short-term interest rate trajectory. With the ECB's summer gathering also on the agenda, insights from Lagarde and Lane may provide additional context for Eurozone monetary policy direction. Key inflation metrics in Europe have recently underperformed expectations, indicating a less aggressive inflation outlook, which should resonate with FX traders as they gauge rate differential impacts.
What the desk is arguing
The desk believes that Federal Reserve Chair Warsh’s impending remarks are likely to adopt a hawkish tone influenced by political pressures to demonstrate independence from the White House. Per the full note, any indication of such political influence could provoke substantial market reactions, especially given the volatile backdrop that may accompany this independence demonstration.
The central bank's recent behavior reflects a more cautious approach, as noted in Donovan's commentary on avoiding guidance to markets. This suggests a potential increase in market volatility, which could be harmful to economic growth if interpreted negatively. For instance, recent inflation metrics point to a cooling trend, which may temper expectations for aggressive Fed rate hikes.
Where it sits in our coverage
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How other firms see it
Firms like jpmorgan and goldman align with a moderately hawkish perspective, anticipating that any Fed policy adjustments will reflect a commitment to combat inflation, while bofa provides a more dovish outlook, citing potential economic headwinds. Market watchers should be aware that USD/EUR and USD/JPY could also reflect the Fed's stance vis-à-vis European and Japanese monetary policy decisions.
What the calendar says
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How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Hawkish signals from Fed Chair Warsh could provoke significant market volatility.
- 02Recent inflation reports in the Eurozone have undershot expectations, easing fears of aggressive ECB actions.
- 03The interplay between US and European monetary policies will be critical in shaping FX trajectories.
- 04Market reactions may hinge on how effective Warsh is in asserting Fed independence in light of political pressures.
Market implications
Traders should focus on any sharp movements in USD pairs following Warsh's public remarks, particularly as expectations shift regarding rate changes. Key resistance around 1.10 in EUR/USD could be challenged if hawkish sentiment prevails.
Risks to this view
A surprise dovish stance from Warsh, along with easing inflation pressures, could lead to significant dollar depreciation, invalidating the current bullish outlook. Additionally, if the ECB signals a more aggressive tightening than expected, this could further complicate the USD's appeal.
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 1st of July. During Congressional confirmation hearings, US Federal Reserve Chair Walsh famously had to deny being US President Trump's sock puppet.
Nonetheless, investors are likely to pore over the text of today's remarks by Walsh looking for the merest hint of hosiery. The rather heavy-handed attempts by the US administration to influence the direction of interest rates means that any sign of politically inspired central bank policy would probably provoke a market reaction. That might then bias the tone of today's remarks towards the hawkish if Walsh feels a need to overhype the hawkish rhetoric in order to demonstrate independence, or at least the appearance of independence.
Walsh has already signalled a desire not to offer guidance to markets, an action that is likely to increase market volatility, and thus the real cost of capital, with potentially negative consequences for economic growth. Of course, the risks of that depend on Walsh having influence at the Fed, and the extent of Walsh's influence at the Fed has yet to be properly tested. Other central bankers are crowding the agenda, for it is the time of the ECB's summer camp for policy makers.
Lagarde and Lane of the ECB might be interesting to listen to. Investors are likely to be disappointed if they are hoping for an apology for the recent ECB policy error, but they might get some kind of commitment not to make the same mistake again, or at least not to make the same mistake again this year. The recent inflation figures in Europe have come in slightly below expectations across all of the major economies, and it's getting a little silly to pretend that the euro area is at risk of some kind of out-of-control inflation explosion.
The euro area aggregate figure for inflation in June is not only likely to come in lower than it did in May, but it may well also come in lower than the published consensus in the wake of the regional figures. Japan's business sentiment poll, the Pankan, was stronger than expected in the second quarter, pretty much across all indicators. The only slight area of weakness was the larger non-manufacturing firms, and this was a pretty negligible disappointment.
Capital spending plans were stronger, although how much of this can be blamed on the enthusiasm for the shiny new toy of artificial intelligence remains to be seen. The Bank of Japan is hardly going to react to a single sentiment poll, even if the Pankan clings to some of the credibility that other sentiment polls have long since lost. But the general narrative around the Japanese economy is consistent with the idea of a further modest rate increase in a few months' time, perhaps particularly in consideration of the recent weakening of the yen.
The US administration has played up the success of talks in Doha over the Gulf War. Qatari officials have been inclined to play down the talks. The US was not talking with Iranian delegates, but with Qatari intermediaries, and presumably also amongst themselves.
The oil market is largely unmoved by all of this, as well it might be. Shipping through the Strait of Hormuz is well below pre-war levels, but it has improved. Investors are content to assume that there's going to be an awful lot of spin in the coming weeks, but given the political costs of the war to Trump, there will eventually have to be something of substance in all these negotiations.
That's all for today. Have a good day. It's subsidiaries, or affiliates, collectively referred to as UBS.
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