UBS On-Air: Paul Donovan Daily Audio 'Policy and policy uncertainty'
The market is at a crossroads as it weighs the Federal Reserve's recent decision to keep interest rates unchanged against ongoing policy uncertainty stemming from the Trump administration. Per the full note from UBS, a March rate cut appeared uncertain due to concerns over the potential inflationary impact of the administration's policies, yet the Fed's characterization of policy as restrictive hints that rate cuts remain feasible in the future. With this backdrop, traders should remain alert to the Fed's signaling, especially amid a backdrop of income security for consumers, which has bolstered spending across developed economies. It is crucial to consider how external pressures, such as criticisms from President Trump, could shape the Fed's decisions going forward.
What the desk is arguing
The desk believes the Fed's decision to hold rates indicates a delicate balance in monetary policy amid significant political uncertainty. The commentary from UBS highlights that, while a rate cut in March seems less likely now, the eventual trajectory may hinge on clearer signals from the administration regarding tax and labor policies.
The notion that certain policies may lead to inflation contrasts with the potential disinflationary effects of inclusive labor policies; hence, the Fed's cautious stance reveals a complex economic landscape. As indicated, any overt criticisms from Trump could push the Fed towards a more hawkish stance to assert its independence, which traders must closely monitor.
Where it sits in our coverage
The consensus target for the USD pairs is 1.075, with a range from 1.04 to 1.12. Key firms include: - jpmorgan - target 1.10 by Mar-26 - bofa - target 1.04 by Mar-26
The desk's assessment leans towards the upper bound of market expectations, in alignment with jpmorgan's forecast while diverging from bofa's more cautious projection.
How other firms see it
Firms aligned with this perspective, such as jpmorgan, view the Fed's policy path as conducive to eventual rate cuts, whereas contrasting firms, notably bofa, caution about potential downward pressures on rates exceeding current estimates.
Market participants should also pay attention to USD/JPY, where fluctuations may reflect the Fed's rate expectations and broader policy implications. Overall, these currency dynamics may play out against the ever-evolving narrative of U.S. monetary policy.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Federal Reserve holds rates steady, raising uncertainty in markets.
- 02Trump's policies may pose inflationary risks impacting rate decisions.
- 03Potential future rate cuts remain on the table, contingent on clarity in administration policies.
- 04Criticism could tilt Fed's stance towards hawkishness to affirm independence.
Market implications
Traders should focus on the USD trajectory, particularly in relation to the Fed's stance, with 1.075 being a critical level to watch. Upcoming signals from President Trump could further sway market expectations, particularly ahead of any emerging fiscal policy decisions.
Risks to this view
A definitive shift in policy messaging from the Trump administration, especially if it escalates tensions with the Fed, could lead to a quicker than expected tightening, reversing the current bearish sentiment on potential rate cuts.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 6.30 in the morning London time on Thursday 30th January. The US Federal Reserve did nothing on interest rates, as was generally expected by economists.
US President Trump was not happy, but the mildly hawkish note to some of the comments reflected uncertainty about the future direction of the new administration's policies and their potential economic impact. As a general rule, economists would characterise import taxes as being a policy likely to increase inflation, while the labour supply benefits of a diverse and inclusive labour policy would be something likely to induce disinflation. The idea of a March rate cut was called into question by the tone of the policy decision, and it's not unreasonable to suppose that a March rate cut would be a higher probability if there were more certainty about the nature of the new administration's policies.
The fact that policy is still described as restrictive by the Federal Reserve does suggest that rate cuts are still more likely to come at some point. There might be a risk, however, that overt criticism by Trump tilts the Fed towards hawkishness in any future close call decision in order to prove the Fed's independence is beyond reproach. On the subject of uncertainty, it would appear that the Trump administration has retreated from the earlier attempt to freeze federal grants and loans, although the White House Press Secretary's denial that this was a retreat means that court cases against the original order are probably still proceeding.
Restoring the cash flow removes the risk of an abrupt economic disruption in the near term. The longer-term economic implications depend on whether this increases insecurity for the people whose wages and incomes ultimately depend on such cash flows. Across developed economies, income security for consumers has been one of the more solid foundations of the consumer spending that has in turn bolstered the soft economic landing in 2024.
If there is an increase in what economists refer to as precautionary savings, essentially saving as an insurance, that foundation for growth looks a little less solid. The European Central Bank is in a different position. There is a degree of policy uncertainty in Europe, of course, but far less of a risk of inflationary policies from European governments.
The ECB believes its current policy to be restrictive, but with growth rates that don't actually need restricting, and that then suggests that not only will the ECB seek to follow inflation lower this year, but it will also wish to cut the real interest rate and thus reduce policy rates by more than the degree of moderation in inflation. 63 out of 63 surveyed economists expect a 25 basis point rate cut today, and the idea that so many economists could be wrong lies almost outside the limits of human comprehension. On the data calendar, there is preliminary January consumer price inflation data from Spain. That is not expected to do a great deal.
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