UBS On-Air: Paul Donovan Daily Audio 'Monetary policy and forever wars'
The desk interprets the recent US employment data as indicative of the Federal Reserve's communication failures surrounding monetary policy expectations. Despite robust job growth, the slow rise in unemployment and stagnant wage growth suggest a more tempered outlook for rate hikes, with the market pricing a mere 60% chance of further tightening. Per the full note , the Fed's inaction on communication could leave markets uneasy in the lead-up to the next policy meeting, especially as geopolitical risks around oil prices elevate concern over inflationary pressures and their potential impact on monetary policy direction.
What the desk is arguing
The desk argues that the US employment report paints a nuanced picture that undermines the Federal Reserve's stated monetary policy framework. Although payrolls exceeded expectations, rising unemployment and flat wage growth highlight a potential disconnect between the labor market's health and inflation trajectory, echoing Paul Donovan's comments on the communication changes at the Fed.
This read aligns with the market reaction, as investors see the probability of a rate hike as a coin flip ahead of the upcoming inflation data release. Stronger employment typically supports Fed hawkishness, yet the lack of wage momentum may cause caution in hike expectations.
Where it sits in our coverage
Our current consensus target for the EUR/USD pair is 1.075, with a range between 1.04 and 1.12. Specific targets from firms include: - jpmorgan - 1.10 (Mar26) - bofa - 1.04 (Mar26)
This desk perspective does not fully align with the cross-firm consensus as some see the potential for further declines towards the lower bound, while the desk's stance remains at the upper end of expectations.
How other firms see it
Firms like jpmorgan are aligned with the desk's view, anticipating a potentially stable or slightly elevated path for rates, while bofa takes a contrary stance with a more dovish outlook. This suggests a division on the outlook for inflation and wage growth amidst the current economic backdrop.
Look to the implications of US inflation data release ahead, as this will be critical for shaping the Fed's response in upcoming meetings, particularly as it relates to the EUR/USD trajectory linked closely to Fed policy shifts.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01US employment data signals communication gaps in Fed's policy stance.
- 02Market pricing indicates uncertainty over near-term rate hike expectations.
- 03Rising geopolitical risks could complicate inflationary pressures.
- 04Stagnant wage growth may influence Fed's future decisions.
Market implications
Attention should focus on how the upcoming inflation data impacts market perceptions of Fed policy. Maintaining a close watch on crude oil prices may also affect the Fed's stance and consequently the EUR/USD movement.
Risks to this view
Key risks include a significant deviation in inflation data that points towards persistent price pressures, compelling the Fed to adjust its communication and potentially expedite rate hikes, which could shift market sentiment dramatically.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Monday the 7th of September. The market reaction to last Friday's US employment report is a rather damning comment on the quality of communications by the US central bank at the moment.
The report was stronger than expected with positive revisions, although those numbers could of course always be revised away. However, the unemployment rate is creeping higher, though slightly less than would actually change the headline number, and critically, any jobs growth is not generating an acceleration of earnings growth, at least not as measured by the average hourly earnings number. Federal Reserve Governor Waller and New York Fed President Williams both put weight on inflation as driving their decisions, and that data comes out later this week.
If there were a clearly understood framework for setting US monetary policy, a report like this would not have changed the certainty of policy direction, at least not this close to a Federal Reserve meeting. As it is, the markets are pricing just over a 60% chance of a rate hike, but effectively the expectation is that of a coin toss. The conventional blackout period on communication from the Federal Reserve is in force, which means that markets are even more adrift for direction.
The US and indeed global inflation story is not going to be affected by the latest rise in the crude oil price, as that's too soon to have any particular impact. However, the attacks on oil tankers by both Iran and the United States have pushed crude oil prices closer to $100 a barrel. This raises questions for the Fed and for other central banks.
Oil price inflation should conventionally be looked through. There's nothing an individual central bank can do to reduce the global price of oil. However, if the war in the Gulf turns into a forever war and the oil price keeps increasing, then the one-off effect of higher oil prices drags on for longer and longer.
Should a central bank aim to slow down the non-oil economy, creating disinflation or deflation there, simply because politicians' inability to end a war is creating more persistent inflation in the oil economy? This was not supposed to be a question that needed answering, as markets' optimism bias did not assume war-induced rising oil prices continuing into 2027. That assumption may now be challenged.
Germany's far-right Alternative für Deutschland is projected to win 44% of the vote in local elections in Saxony-Anhalt. The win was expected, and Saxony-Anhalt is not a large lander in Germany, but it has provoked a political reaction. With a year of elections in Europe in 2027, the role of the far-right adds uncertainty to economic policy, and markets do not tend to enjoy uncertainty, especially political uncertainty.
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