UBS On-Air: Paul Donovan Daily Audio 'More violence, same response'
Lead — The resurgence of violence in the Gulf has prompted a sharp increase in crude oil prices, presenting a potential challenge for consumers and political stability in the US. Per the full note from UBS, Brent crude is now above $90 per barrel, accompanied by rising gasoline prices in the US approaching $4 per gallon, escalating political tensions ahead of the upcoming mid-terms. The desk emphasizes that the pass-through of oil costs to consumers may be sustained if household balance sheets remain strong, despite expectations for natural demand contraction. Upcoming economic pressures may lead to shifts in consumer spending habits as political pressures mount, particularly as the average consumer remains sensitive to price increases amid geopolitical tensions.
What the desk is arguing
The desk frames this as a crucial moment for commodity-based currencies, especially as geopolitical risk in the Gulf rises. The recent uptick in Brent crude prices to over $90 per barrel signifies a return of market volatility, which can have wide-ranging repercussions on global FX markets.
As per UBS's analysis, average gasoline prices in the US have climbed towards the politically sensitive mark of $4 per gallon, creating a fertile ground for political discontent as consumers grapple with higher living costs. Companies appear to be passing through these costs effectively, which could sustain earnings growth; however, a shift in household spending as consumers lean on savings could introduce new challenges.
Where it sits in our coverage
Our analysis aligns closely with jpmorgan, which has set a target of 1.10 for the EUR/USD pair through March 2026, while bofa holds a contradictory view with a target of 1.04. This divergence illustrates that given the current volatility in oil markets and consumer sentiment, our perspective on currency movements remains aligned with the broader trend of strengthening commodity-linked currencies amidst geopolitical strife.
How other firms see it
Firms like jpmorgan and others are similarly focused on the inflationary pressures stemming from rising oil prices, aligning their views on a potential upswing for USD and commodity-linked currencies. Conversely, bofa appears more cautious, suggesting that a rapid cooling in consumer sentiment could unwind some of these pressures.
As this narrative unfolds, keep a close eye on energy-related commodities, particularly USD/JPY, as shifts in oil could influence the broader market sentiment in riskier assets. The geopolitical dynamics may also spillover into EUR/USD, drawing parallels not only to oil price movements but to broader central bank policies on inflation as well.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Brent crude prices have breached $90 per barrel, signaling increased geopolitical risk and potential inflationary pressures.
- 02US gasoline prices are nearing $4 per gallon, creating a politically charged atmosphere ahead of mid-term elections.
- 03Consumer spending resilience despite rising costs indicates potential challenges down the line for economic stability.
- 04Commodity-linked currencies may benefit in the short term from sustained demand and price pass-through.
Market implications
Watch the $90 level on Brent as a critical threshold; its sustained breach may drive further volatility across commodity-linked currencies. With US inflation dynamics being impacted by rising energy costs, upcoming political discussions around these price levels could play a crucial role in shaping market sentiment.
Risks to this view
The call may face challenges should Iran's actions escalate to a point where broader military conflict ensues, drastically affecting oil supply without a corresponding demand response. Conversely, should US consumer sentiment worsen significantly, it could catalyze a shift back towards safety, negating the advantages of commodity currencies.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 1.30 in the morning London time on Monday the 20th of July.
Ongoing violence in the Gulf has had some impact on the world's financial markets. Iran has been firing ballistic missiles that had supposedly been destroyed at US military bases. The Brent crude oil future breached $90 per barrel.
Of more political relevance, the average price of gasoline in the United States was hovering just below $4 per US gallon on Saturday. Remember, most US consumers think the price should be around $2.50 per US gallon, the level it was before the war began. With a majority of Republican voters blaming US President Trump for the cost of living crisis, that is politically relevant.
The immediate geopolitical concern is whether Iran decides to escalate the situation still further and seek to block the Red Sea via attacks by the Houthi. The Red Sea route accounts for about 7% of global oil supply at the moment. And the use of this route has been one of the things that has contained the rise of crude oil prices to date.
The economics of the situation remains the same. The Wiley-Coyote effect continues, consumers relying on things other than income to spend. This can carry on for some time before economic gravity exerts itself.
Consumers in developed economies are willing to cut back on how much they save each month rather than to cut back on their consumption in order to afford the higher oil price. This explains the resilience of earnings growth too. Companies have been quick to pass through oil price increases to the end consumer.
But if demand is not affected by the rapid pass-through of oil costs, then the earnings levels are unaffected also. The consumer response does depend on the animal spirits of the consumer. But given the strength of household balance sheets, it is something that is likely to be sustained through the second half of this year should the oil price remain elevated and the US fail to make concessions.
If the oil price falls, there is no need for economic gravity to take effect. If the oil price fails to drop, then economic gravity becomes a risk but in 2027, after the Christmas spending period. The data calendar is very quiet with German producer price inflation for June about all there is of any note.
European inflation data has tended to surprise to the downside. But as only five economists have bothered to reply to the consensus survey for this particular data point, comparisons to expectations are just about as meaningless as it can get. We are in the quiet period ahead of policy meetings by both the US Federal Reserve and the European Central Bank, which gives a merciful break from the commentary of central bankers.
US President Trump did suggest that the best way to tackle Canadian wildfires was not to send specialist firefighting equipment but to tax US importers of Canadian made products. The threat was made on social media and the instinctive response of markets is likely to be to just ignore it. There is now quite a body of social media posts threatening more tariffs on US consumers which have not been followed through.
With members of the administration seemingly happy to overlook Trump's stated desires. That's all for today. Have a good day.
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