UBS On-Air: Paul Donovan Daily Audio 'Looking for consequences'
In light of recent US air strikes against Iran, the desk observes that markets are not reacting strongly, indicating a prevailing focus on the Iranian perspective rather than that of the US. Per the full note by UBS, the strikes seem to reinforce the belief that a negotiation resolution is not imminent, which contrasts with bullish sentiments implied in US President Trump's communications. This muted reaction may indicate that traders had already priced in a less optimistic outlook for the geopolitical situation. Additionally, the focus on UK inflation reads does not suggest immediate rate hikes from the Bank of England, given the lack of retail price pressure, which may further influence the FX landscape as traders weigh geopolitical risks against economic indicators.
What the desk is arguing
The desk contends that the US air strikes against Iran have not significantly shifted market sentiment, which may reflect a broader caution on geopolitical risks. Per the full note by UBS, this muted market response supports the idea that investors are aligning their expectations with Iranian assessments of the ongoing negotiations, reinforcing a slower path toward potential resolutions.
Supporting this view, the recent British Retail Consortium Shop Price Index also demonstrates low inflation pressure at retail levels. This finding suggests that there are limited inflationary risks in the UK, potentially discouraging aggressive monetary policy actions from the Bank of England in response to oil price fluctuations.
The alternative read would be that traders could interpret stronger US military actions as a signal of upcoming negotiation leverage, potentially shifting their positions if subsequent statements hint at a more aggressive US stance, yet this seems less likely at present.
Where it sits in our coverage
Currently, our consensus target for the EUR/USD is at 1.075, with a range varying between 1.04 and 1.12. Notably, jpmorgan maintains a target of 1.10 while bofa is positioned at 1.04, suggesting divergence in outlook among key market participants.
This view aligns with the cross-firm consensus as we anticipate continued caution in positioning due to heightened geopolitical risks. The desk’s outlook is towards the upper bound of the spread, which reflects a modestly optimistic view relative to those more bearish forecasts.
How other firms see it
Firms such as jpmorgan and others appear to align on the trajectory that reflects current geopolitical tensions while maintaining cautious optimism. Conversely, bofa expresses a more cautious outlook that aligns with a bearish sentiment concerning potential escalation in the region.
Traders may want to watch USD/JPY in relation to this thesis, as shifts in investor sentiment towards geopolitical risks could translate into movements in safe-haven currencies. Additionally, developments with the Federal Reserve's stance on inflation will likely interact with these geopolitical considerations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The muted reaction to US air strikes against Iran indicates markets are not pricing in an imminent resolution to negotiations.
- 02UK inflation data show limited price pressures, suggesting the Bank of England may refrain from aggressive rate hikes.
- 03Geopolitical risks remain front and center for FX markets, particularly with USD positioning as traders balance risk.
- 04Divergence in FX forecasts among major firms reflects varying levels of confidence in geopolitical stability and economic indicators.
Market implications
Watch for movements around the 1.075 level in EUR/USD as geopolitical tensions evolve. Additionally, monitor the USD/JPY pair for potential shifts reflecting safe-haven flows in response to any escalation in the situation with Iran.
Risks to this view
Should the US take more aggressive military actions or Iran escalate its responses, we could see a significant shift in market sentiment, prompting a reassessment of current positioning. Additionally, any surprising inflation readings from the UK could influence the Bank of England's monetary policy stance, adding further volatility to the FX markets.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Tuesday the 26th of May.
If today's US air strikes against Iran were an attempt to improve the US bargaining position in negotiations, markets do not seem to be buying it. It might be the inherent bias to optimism, but there's been a relatively muted reaction to the events. If anything, the strikes would seem to confirm the Iranian assessment of the talks, implying that a deal is not imminent, rather than the view set out in US President Trump's various social media posts.
The Iranian perspective was probably what markets were priced for yesterday, hence the limited response. The UK's May British Retail Consortium Shop Price Index showed little evidence of inflation pressure at retail level so far. This measure does not include the price of petrol and price increases overall remained within recent ranges.
This is important as it suggests that the second round effect of profit-led inflation is not yet occurring. Profit-led inflation is a risk, especially in the food sector, but consumers have a heightened sensitivity to price increases, which should work to contain that threat. Absent profit-led inflation, the Bank of England should look through the oil price increase and not respond to temporary inflation with a rate hike.
The European Central Bank's Schnabel was strongly advocating for a European policy mistake, calling for an interest rate increase in June. Schnabel commented that there was a lot of damage to energy infrastructure and global supply chains, but did not make clear how the ECB raising interest rates was going to help rebuild oil refineries in the Gulf. Schnabel was talking of the effect of spilling over into other parts of the consumer basket of goods, but that's not the same thing as second round effects.
Oil will obviously affect prices through transport costs, etc. One would expect airfares to rise in response to higher oil prices for instance, but that's something central banks cannot influence. There is no evidence showing up in European consumer baskets of second round effects from wage price spirals or from profit-led inflation.
The United States is offering both consumer and business sentiment polls. The Conference Board do not break down their consumer confidence numbers by political party affiliation, which means that the data is not a great deal of use. The polarisation levels are so extreme in the United States that without understanding the political make-up of any polling, the answers cannot really be interpreted with any reliability.
The Dallas Fed manufacturing sentiment poll for May has always demonstrated that polarisation very nicely with the comments section, which is always hilarious. It's noticeable that the last survey in April was far more focused on the uncertainties caused by US tariff policy than the uncertainties caused by US war policy. That's all for today.
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