UBS On-Air: Paul Donovan Daily Audio 'Military fallout'
The desk interprets the recent missile exchanges between Iran and Israel as a factor that currently lacks significant impact on financial markets, suggesting that unless energy supply disruptions escalate, the overall economic effects will remain muted. Per the full note from UBS, the markets reacted minimally to the surprise of Israel's initial strike against Iran, with market participants seemingly well-prepared for further conflict in the region. Inflation concerns are highlighted, particularly the potential impact on US consumer prices as energy costs rise alongside ongoing trade tensions. This backdrop positions the desk's view in alignment with cautious investor sentiment as reflected in the consensus economic outlook.
What the desk is arguing
The core thesis is that while geopolitical tensions have escalated in the Middle East, the financial markets appear resilient, primarily due to the established market expectations surrounding such conflicts. According to UBS’s Paul Donovan, the reactions observed following Israel's strikes were anticipated, preventing any dramatic shifts in investor sentiment or market activity.
Supporting this view, Donovan notes that the minimal repercussions in financial markets can be attributed to a lack of expectation for severe disruptions in energy supplies or shipping routes, which are typically the main concerns in such scenarios. The key metric to watch will be inflation perceptions in the United States, as rising energy prices could erode consumer spending power.
Where it sits in our coverage
Our current consensus target for inflationary impacts linked to energy prices sits at a USD inflation expectations target of 1.075, with a range between 1.04 and 1.12. Specific firm forecasts include: - jpmorgan (target 1.10, tenor Mar26) - bofa (target 1.04, tenor Mar26).
The desk’s outlook aligns closely with the upper bounds of the projected range, indicating that we expect continued inflationary pressures to linger in the near term.
How other firms see it
Among aligned firms, jpmorgan anticipates similar inflation trends, while bofa offers a contrary stance, predicting lower inflation expectations in response to current conditions. This divergence points to differing interpretations of potential energy price escalations and consumer responses.
Market dynamics around EUR/USD will be crucial to monitor, especially how the European Central Bank may react to changes in energy prices and inflation metrics in the Eurozone, as these factors could carry spillover effects into broader financial markets.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Geopolitical tensions between Iran and Israel currently lack major financial market impact.
- 02Inflation perceptions in the US could shift significantly as energy prices increase.
- 03Investor sentiment appears resilient due to established expectations of conflict.
- 04Upcoming trade negotiations may be influenced by state of US consumer prices.
Market implications
Traders should be vigilant regarding USD inflation expectations, particularly as energy prices rise, with a key level to watch being 1.075 for signals regarding future price movements and consumer sentiment. The ongoing trade negotiations and their potential outcomes will also significantly influence market behavior in the medium term.
Risks to this view
A marked escalation in military conflict that disrupts energy supplies or shipping routes would invalidate the current outlook, causing rapid shifts in market sentiment and substantial impacts on inflation metrics. Furthermore, unexpected shifts in US trade policy could also alter perceptions and market reactions significantly.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management at 6.30 in the morning London time on Monday the 16th of June. The ongoing exchange of missile strikes between Iran and Israel over the weekend has not changed things very much for financial assets. Market moves on Friday reflected the unexpected scale of Israel's initial attack on Iran.
Deficits over the weekend do not appear to have been so surprising to investors given the scale of that initial attack. The normal consequences of Middle East conflict are well known with threats to the oil price and to shipping routes. A further reaction from financial markets would be justified only if there were expectations of a more dramatic disruption to energy supplies or to shipping lanes.
At this stage, that does not seem to be the case. In terms of the economic consequences of the existing market moves, these remain relatively slight. The main issue is likely to be around inflation perceptions in the United States.
Higher energy prices will be hitting US consumers just as the trade taxes start to push up consumer prices across a range of products. The perception of inflation will shift because energy is a high frequency purchase and the spending power of US consumers will be affected as both forms of price increase come in. This might conceivably weaken US President Trump's position in trade negotiations somewhat further as upset US consumers will be a factor that international negotiators will be very much aware of.
Trump's unpredictable negotiation stance and the absence of trade deals to date from which to draw parallels means that this cannot be certain, but the probabilities that markets ascribe to trade outcomes are likely to shift if US inflation rises further, even if the reasons for that increase are not directly trade tax related. It seems unlikely that the G7 leadership summit will produce much for financial markets. Summit summits are nearly always about spin rather than substance.
Three of the G7 leaders are new, assorted non-G7 leaders are attending, and there is to be no formal communique, but instead a series of thematic statements. As a general rule, the larger the collection of leaders at any event, the less likely it is that anything of any importance will change, as the G20 has so admirably demonstrated over the years. The data calendar is not likely to distract too much from the politics.
The US Empire State Sentiment Poll of Business Sentiment deserves very little attention as it's very unlikely to reflect economic realities. China's May retail sales data was stronger than expected, but this in all probability reflects an earlier shopping festival, which may have then pulled spending into May at the expense of spending in June. India's spending, which is less affected by such things, was a lot more stable.
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