UBS On-Air: Paul Donovan Daily Audio 'In what can we trust?'
The desk believes that the Federal Reserve's recent stance indicates a growing concern about inflation's threat level compared to unemployment, heightening the need for investor trust in U.S. monetary policy. This perspective aligns with insights from UBS, where they emphasize that the lack of surprise in the Fed meeting minutes—favoring inflation management—suggests an erosion of perceived independence in policy-making. Given that trust is paramount in a fiat currency environment, signals from the Fed could greatly influence the U.S. dollar's value and its reserve currency status.
What the desk is arguing
The desk argues that the Federal Reserve's focus on inflation over unemployment further complicates the market's perception of its independence, reflecting concerns about the health of the U.S. dollar. Per the full note from UBS, the focus on inflation underscores a critical pivot for policymakers, potentially leading to shifts in market sentiment.
Supporting this view, a strong majority of Fed members suggested inflation is a more pressing issue, likely solidifying market expectations for tighter monetary policy. The emphasis on inflation suggests that rate hikes may be revisited if necessary, constituting a shift from any dovish signals seen previously—an approach that could have serious implications for dollar strength.
Where it sits in our coverage
Current consensus points towards a target of 1.075 for the EUR/USD exchange rate, with a range between 1.04 and 1.12. Notable targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This perspective aligns closely with jpmorgan, though bofa provides a distinctly more bearish outlook, positioning the desk’s stance at the higher end of the current consensus spread.
How other firms see it
Several firms, including jpmorgan and goldman, align with the desk's view that inflation will dominate Fed policy going forward, indicating a strengthening dollar. In contrast, bofa proposes a more cautious approach to the dollar's appreciation, citing fears of further political interference in Fed operations.
Watch the USD/JPY for potential spillover effects tied to Federal Reserve policy adjustments, particularly as they impact market sentiment on inflation pressure and central bank credibility.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Federal Reserve prioritizes inflation concerns over unemployment risk, as indicated in the latest minutes.
- 02Erosion of trust in Fed independence could jeopardize the U.S. dollar's status as the reserve currency.
- 03Increased inflation management could lead to market adjustments in monetary policy expectations.
Market implications
Traders should monitor key thresholds around 1.075 for EUR/USD, as any signal of unexpected inflation management could shift market sentiment and set new trading ranges. Price action around this level could indicate changing perceptions of Fed independence and its implications for the dollar's strength.
Risks to this view
A significant shift in investor sentiment regarding the Fed's independence—prompted by political pressures or surprising policy decisions—could lead to a sharp reversal in the current bullish sentiment towards the dollar and result in weakening exchange rates.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Thursday the 21st of August. The US Federal Reserve meeting minutes, published yesterday, did not really contain any surprises.
The fact that a majority saw inflation risks as being greater than employment risks is simply consistent with the decision that was taken, and with the general state of things as first and second round effects from trade taxes start to emerge. Of more concern is what appears to be a renewed attack on the independence of the Fed, with US President Trump calling for a Democrat-appointed governor to resign. Regardless of the circumstances of this specific case, Trump's social media postings, in conjunction with other comments around the Fed, give the appearance of wishing to reduce its independence.
A fiat currency system depends on trust. The word even appears, somewhat controversially, on US dollar bills. Spin is therefore something that does matter a great deal.
With the independence of the central bank and the independence of economic data in the United States both causing the economics profession some concern, the role of the dollar as a reserve currency is becoming increasingly vulnerable. We get the release of US jobless claims data today, which give an incomplete picture of the labour market, but one that will still attract attention. The US corporate narrative of not hiring, not firing, suggests that continuing claims are likely to increase.
Someone unfortunate enough to lose their job will take longer to find a new one. New entrants to the labour force will also take longer to find work, but they will not appear in claims data. There is the dull background noise of business sentiment opinion polls from the glittering wonder that is the Euro and the United States today.
There is a risk that if people lose faith in the independence of official statistics, they will turn to things like sentiment surveys instead. However, in the absence of definitive data on what is actually happening in the economy, it becomes increasingly difficult to judge whether such surveys are accurate or not. In that case, some investors may start to take sentiment polls at face value and assume that people answer the questions accurately and that the data measures what it claims to measure.
That would be a grave error. Just because something is labelled new orders or employment intention, there is no guarantee that the survey response actually reflects the reality. Fiscal policy remains a focus in the UK, although the fact that the UK has been, by some margin, the fastest growing G7 economy year to date, does help mitigate some funding concerns.
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