UBS On-Air: Paul Donovan Daily Audio 'Oil’s tariff playbook'
The desk views the current oil market dynamics as pivotal, given their parallels with past trade tensions and their implications for global monetary policy. As outlined by Paul Donovan at UBS, the escalation of the Gulf conflict has propelled oil prices back to the $100/barrel threshold, which in turn has rekindled concerns regarding potential US interest rate hikes. Per the full note, the cyclical response of the US to market pressures reflects a broader uncertainty that traders must navigate. This context is crucial for institutional FX strategies as they assess the impact on key currency pairs against elevated oil prices.
What the desk is arguing
The desk asserts that rising oil prices driven by geopolitical tensions directly influence US monetary policy, with wider ramifications for global currencies. Per the full note by UBS's Paul Donovan, this interplay is similar to historical trade tensions, where market reactions lead to policy retreats. As oil crosses the $100 mark, traders must evaluate potential shifts in US interest rates as a result of inflation concerns tied to energy prices.
Additionally, Donovan highlights that the volatility in oil supplies stemming from Middle Eastern conflicts contrasts with the unilateral nature of US tariff actions, suggesting a more complex global economic response. This positions oil prices as a critical variable in forecasting US monetary policy adjustments and subsequent currency movements.
Where it sits in our coverage
Our consensus target for USD/JPY sits at 1.075, with a range from 1.04 to 1.12. Specific firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk's analysis aligns closely with jpmorgan's target, suggesting a bullish stance on the USD in the face of escalating oil prices, which could affect US interest rate policy. This positioning is at the upper bound of the range, indicating a sentiment favoring a stronger dollar against potential inflationary pressures.
How other firms see it
Firms such as jpmorgan and dbs align with the desk's interpretation of rising oil prices impacting US monetary strategy. In contrast, bofa argues for a cautious approach to currency movements in light of broader geopolitical uncertainty.
Watch the USD/JPY trajectory, particularly as it may reflect incoming data on US inflation and energy prices amidst ongoing geopolitical tensions. The interplay between oil price movements and the Federal Reserve's rate path will be crucial to watch for traders.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Escalating Gulf conflict elevates oil prices above $100/barrel.
- 02Rising oil prices rekindle US interest rate hike concerns.
- 03Market reactions to oil prices directly influence monetary policy adjustments.
Market implications
Market participants should closely monitor the USD/JPY pair as elevated oil prices could lead to significant currency movements. A decisive shift in oil prices could prompt reassessments of US interest rates, impacting market sentiment around the dollar.
Risks to this view
A de-escalation of geopolitical tensions could reverse the current oil price trend, diminishing inflation concerns and thereby prompting a reassessment of the expected US interest rate path. Conversely, a widening conflict could exacerbate supply concerns, driving prices further and solidifying a hawkish tilt from the Fed.
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 27th of July. The pattern of the Gulf War is starting to play out something like that of the trade war.
The US 2025 tariff policy went back and forth. US President Trump would make a declaration, there would be a strong market reaction, and then there would be a policy retreat in the face of that market reaction. The problem with this strategy is that over time investors began to anticipate the retreat, meaning that there was a more muted market reaction and thus the pressure to bring about the retreat lessened.
With the Gulf War, the escalation of the conflict pushed the oil price back above $100 per barrel and that gave fresh life to fears of US interest rate increases. The US then retreated from its aggressive stance. There are two differences between the tariff catch-22 and the Gulf War catch-22.
US tariffs were always primarily a unilateral event, the rest of the world didn't need to respond. The war requires Iran to respond in a similar vein. It was only really with the Iranian decision to halt strikes in the wake of the US policy change that the oil price began to fall.
Second, the damage of the tariff policy was largely confined to the US economy. The rest of the world has carried on trading quite nicely and global trade is at record highs relative to GDP. The main global transmission mechanism was via expectations for US interest rate increases in the wake of rising US inflation.
The changeable US policy on the Gulf has direct consequences for the global economy via the price mechanism in the oil market and potentially through physical constraints of shortages of oil supply. China released June data for industrial profits. This is not necessarily a show-stopping data release but it has become more important politically.
The rise of economic nationalism in the global economy has encouraged politicians to accuse China of dumping goods into global markets. The point about trade dumping is that the exporter is selling at a loss in order to gain market share, to get rid of overcapacity or indeed to drive competitors into bankruptcy. The flaw in that narrative is that China's industrial profits continue to grow.
There is quite a range of profit experiences and some sectors may still be open to accusations of dumping. The problem is that domestic demand in China is weak and that must be assumed to impact profitability in those areas that have reasonably high levels of domestic demand exposure. But to make a general accusation of trade dumping by China is just not backed by the economic data.
There are some sentiment data releases cluttering up the calendar today. The US Dallas Fed manufacturing survey with its ever-entertaining comments section is due as is the July German EFO poll of corporate expectations. The United States is also offering durable goods data which is of some interest in giving insight into the nature of investment spending in the US at the moment.
That's all for today. Have a good day. UBS AG, regulated by FINMA in Switzerland.
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