UBS On-Air: Paul Donovan Daily Audio 'Inflation bonanza'
Per the full note [UBS On-Air], Paul Donovan argues that May US headline CPI will rise sharply as Iran war-related energy costs pass through rapidly due to consumers' heightened inflation awareness from pandemic and tariff experiences. Unlike past supply shocks, firms are not absorbing margin hits, and core inflation remains subdued with second-round effects absent. The focus shifts to policy response and political consequences rather than demand destruction.
What the desk is arguing
The desk frames this as an 'inflation bonanza' where the transmission of higher energy prices is unusually fast and complete. Donovan stresses that the Iraq War narrative, combined with consumers' recent experience of pandemic and tariff-driven price increases, has removed the typical lag or margin squeeze that softens pass-through.
Supporting the thesis, the source notes that nominal consumption is outpacing nominal income, and inflation is growing faster than income, forcing consumers to tap savings. The labour market's stability enables this dynamic, but the real concern is whether other prices—especially services—begin to rise, which has not materialized yet.
The alternative read would be that if demand weakens, firms may eventually face margin pressure despite the rapid pass-through, potentially curbing the inflation spike. However, Donovan sees this as less likely given current consumer behavior.
Where it sits in our coverage
Omitted due to lack of internal coverage data.
How other firms see it
Omitted due to lack of internal coverage data.
What the calendar says
Omitted due to no high-impact events in the next 30 days.
Key takeaways
- 01May US headline CPI expected to rise sharply due to rapid pass-through of Gulf war-related energy costs.
- 02Core inflation remains subdued with no signs of second-round effects; services inflation is a key monitor.
- 03Consumers are drawing down savings as nominal consumption and inflation outpace income growth.
- 04Policy response and political consequences are the primary focus, not demand destruction from inflation.
Market implications
Watch EUR/USD for spillover from US inflation data; a hot print could reinforce Fed hawkishness and support the dollar. Focus on energy-linked currencies (e.g., USD/CAD) and any shift in breakeven rates.
Risks to this view
A sudden demand pullback or geopolitical de-escalation could reverse the rapid pass-through. If second-round effects emerge in services, the Fed may tighten faster than expected, amplifying recession fears.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's six o'clock in the morning London time on Wednesday the 10th of June. US May consumer price inflation data is assuming increased importance for investors.
The headline data is expected to rise because the costs of the US war in the Gulf are being passed through relatively quickly to domestic consumers. Sometimes an external price shock will be passed through with a delay or a more muted impact when, for instance, companies along the supply chain are prepared to take a squeeze on profit margins. However, the very dominant narrative of this particular shock means everyone is very aware that prices will rise.
The recent history of the pandemic supply shocks and then the additional costs of US tariffs have made consumers more used to the idea of price increases. Not happy about them, but not surprised by them. That combination has allowed the higher energy costs to be passed through rapidly and completely, which means in turn that as long as demand does not weaken, companies are much less likely to take any hits to their profit margins.
The core inflation rate will reflect some higher energy costs too, but these will be less significant. The higher US headline inflation rate is why consumers have had to tap into their savings. Nominal consumption is growing faster than nominal income at the moment, and inflation is also growing faster than income.
The stability of the US labour market has allowed consumers to do all of that. So far, the main questions around inflation in the States are less about the potential for demand destruction and more about the policy response and the political consequences. On the policy response, the issue is not passing through oil prices, but whether there are any signs of other prices picking up, the second round inflation effects.
These have been largely absent from the data. Areas like service sector inflation will be a focus in the details of today's numbers in this regard. The political consequences focus on the approval rating of US President Trump, which for economic management and inflation management specifically has slumped in recent weeks.
Even Republicans are moving beyond partisanship to blame the President for the affordability crisis. That may already have some consequences. The exemptions to the latest wave of proposed tariffs US consumers are being asked to pay or the attempts, so far ineffective, to try and extricate the US from the Gulf War.
China's inflation is much, much less relevant to the global economy. The world does not tend to hold its breath in anticipation of the next People's Bank of China decision, and China's domestic consumer price inflation is a parochial affair with little relevance beyond its borders. May consumer price inflation was slightly weaker than had been anticipated, with collapsing pork prices a part of the drag on the overall index.
Sources & References
How we cover this story