UBS On-Air: Paul Donovan Daily Audio 'Nervousness about policy'
The January FOMC minutes reveal a Fed wary of Trump's policy impact, particularly the risk of a new inflation wave via tariffs and immigration restrictions. Companies may pass on higher costs more readily than during Trump's first term, given consumers' heightened inflation sensitivity post-pandemic. Markets discount Trump's offhand remarks on a China trade deal, focusing instead on the Fed's cautious stance. This keeps the dollar bid but leaves USD longs vulnerable to any softening in tariff rhetoric or growth data.
What the desk is arguing
UBS Chief Economist Paul Donovan argues the Fed's January minutes signal heightened caution on rate policy due to nervousness over Trump's economic agenda, specifically the risk that tariffs and immigration restrictions reignite inflation. The key novelty versus Trump's first term, per the full note [UBS On-Air], is that companies now feel emboldened to pass through trade taxes to consumers because post-pandemic inflation has conditioned them to accept price increases.
Donovan warns of "profit-led inflation" where retailers use tariffs as a cover to expand margins, reprising the third wave of COVID-era inflation. He dismisses Trump's offhand comment about a possible China trade deal as low-probability, given the President's pattern of eccentric public statements. Markets are applying a large discount to such announcements.
How other firms see it
Aligned firms include JPMorgan and Goldman Sachs, which both highlight tariff-driven upside inflation risks and a slower Fed easing cycle. Morgan Stanley is more cautious on USD upside, flagging that growth concerns could eventually cap rate expectations. Citigroup and Deutsche Bank are contrarian, arguing that Trump's bark may be worse than his bite and that the Fed's caution is already priced.
Related pairs to watch: USD/CNH for trade deal headlines, EUR/USD for rate differential shifts as the ECB stays more dovish than the Fed. The DXY index will reflect the Fed's caution versus other central banks.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed minutes show nervousness over Trump's policies reigniting inflation via tariffs and immigration restrictions.
- 02Companies likely to pass through tariff costs more readily than in 2018-19 due to heightened consumer price sensitivity.
- 03Markets heavily discount Trump's offhand China trade deal remark; focus remains on policy risk.
- 04UBS sees profit-led inflation as a real risk, with retailers using tariffs to expand margins.
Market implications
Watch for further USD strength if tariff announcements escalate, especially against EM and Asian currencies. A break below 1.0750 in EUR/USD would confirm dollar momentum, while a dovish Fed surprise would reverse the trend. Monitor US CPI releases for signs of pass-through inflation.
Risks to this view
A sudden US-China trade de-escalation or Trump backing down on tariff threats would reverse the narrative and weaken the dollar. Conversely, a sharp drop in US growth data could force the Fed to cut despite inflation, hurting USD. The key risk is that profit-led inflation proves transitory, leaving the Fed too hawkish too long.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Thursday the 20th of February.
The US Federal Reserve's minutes from their January meeting signalled caution on future interest rate policy. Essentially, all options are open, but there is clear nervousness about the economic impact of US President Trump's policies. In particular, the idea that Trump may ignite a further wave of inflation through immigration policy and aggressive consumer taxes on imports.
On the latter point, it was noted that companies were signalling an intention to pass through higher trade taxes to end consumers. This differs somewhat from the trade tariffs of Trump's first term in office. Then, higher taxes were imposed at a time when consumers were more used to stable prices.
Because of the three waves of the post-pandemic inflation, consumers have become more attuned to the idea that the higher prices do happen. And that means that companies may feel emboldened to pass on more of the tax in the form of price increases. The real risk is that retailers will reprise the third wave of post-pandemic inflation and indulge in some profit-led inflation again, using Trump's taxes as an excuse to increase profit margins and raise prices further.
Meanwhile, Trump has signalled that a trade deal with China might be possible. There are no details and this was just a remark made in passing to reporters. Given the President's trend towards eccentric comments, likening themselves to a king, etc., financial markets are not likely to place too much weight on a casual remark.
Investors who assess real world probabilities are tending to apply quite a large discount to Trump's public announcements. Financial policy is another instance of this. Trump has also suggested that 20% of any efficiency savings from megadonor Musk's operations in government could be returned to taxpayers.
Given that the difference between claimed savings and actual savings is quite large, any serious attempt to disperse fictional savings would be a significant increase in the federal budget deficit. Bond investors, however, are unlikely to take these pronouncements too seriously. German producer price inflation for January came in significantly lower than had been expected, although relatively few economists actually forecast this number, making the consensus a rather weak indicator.
Nonetheless, prices fell on the month and it's a signal of very limited underlying inflation pressures. While the US Federal Reserve is fretting about possible price increases, the ECB is more likely to be focused on the potential for disinflationary forces to dominate. There are some sentiment indicators due.
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