UBS On-Air: Paul Donovan Daily Audio 'Prices and productivity'
This commentary highlights the tensions surrounding the Federal Reserve's role in driving inflation and the broader implications of productivity assumptions on policy. Per the full note , Fed Chair Warsh's testimony suggests a narrow view of inflation causality that primarily places blame on the Fed, despite evidence indicating external factors, like tariffs, accounted for additional inflationary pressures. Additionally, his uncritical stance on artificial intelligence as a productivity booster raises concerns over possible policy missteps. These insights resonate within the ongoing discourse about monetary policy, inflation trajectories, and market expectations regarding future Fed actions.
What the desk is arguing
The desk argues that the Fed's stance on inflation, as articulated by Chair Warsh, could severely influence policymakers' approaches to future economic challenges. The implication that the Fed is solely responsible for inflation overlooks various external pressures, notably the contribution of tariffs that recent Fed research attributes to roughly 1 percentage point of last year’s inflation.
Furthermore, the desk expresses caution towards Warsh's optimistic view on artificial intelligence's impact on productivity—a potential miscalculation if technology does not deliver as expected. This insight suggests that traders should be wary of adopting overly bullish narratives surrounding technological advancements as drivers of macroeconomic stability.
Where it sits in our coverage
Our current consensus target for USD/JPY sits at 1.075, with a range between 1.04 and 1.12. Specifically, firms show the following targets for March 2026:
The desk's forecast aligns closely with JPMorgan's view, sitting slightly above the midpoint of the established range, while BofA's projection indicates a bearish sentiment that starkly contrasts our outlook.
How other firms see it
Several firms align with our interpretation, suggesting a cautious approach to the Fed's monetary policy amid persistent inflationary pressures, particularly JPMorgan and Goldman Sachs. In contrast, BofA offers a more pessimistic view, advocating for tighter monetary policy in response to inflation.
Traders should keep an eye on indicators like U.S. inflation data and Fed communications as they continually reassess market positions and the likelihood of shifts in the Fed's strategy.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed Chair Warsh's testimony emphasizes responsibility for inflation and risks over-reliance on AI for productivity gains.
- 02Recent Fed research indicates that around 1 percentage point of inflation was driven by tariffs.
- 03Market players should approach narratives about productivity advancements with caution, assessing realistic outcomes.
Market implications
Traders should monitor USD/JPY around the 1.075 level, particularly following any signs from U.S. inflation data that might influence Fed direction. A clearer understanding of productivity effects amidst inflation could lead to repositioning in FX markets.
Risks to this view
A significant reversal in mood could occur if subsequent inflation data diverges from current expectations or if new tariffs are announced, forcing the Fed into tighter monetary policy sooner than anticipated.
Good morning. This is Paul Donovan, Chief Economist at GBS Global Wealth Management. It's six o'clock in the morning London time on Wednesday, the 15th of July.
US Federal Reserve Chair Walsh sounded almost German in testimony to Congress yesterday, reiterating an extreme aversion to inflation and a refusal to be comforted by the most recent price data. Walsh also emphasised that inflation was the Fed's responsibility and no one else's responsibility, which is a bit of a stretch when the Fed's own research ascribes around one percentage point of last year's inflation to the effects of US tariffs. It is also unlikely that a statement in Congressional testimony from the Fed Chair is high profile enough to change voters' inclination to blame US President Trump personally for the current inflation levels.
The contradictory and somewhat troubling element of Walsh's testimony was his seemingly deep-rooted belief in the productivity pixie and the ability of AI to change the nature of inflation in the economy. Technology shocks can and do change relative prices in an economy. But as the recent inflation aspects of the tech boom demonstrate, some prices will go up but some prices will go down in these circumstances.
That does not equate to a clear trend in terms of overall inflation. If Walsh really believes these comments there is then a risk of a miscalculation that produces higher inflation in the future. Economists and bond traders have been battling it out over views for the Federal Reserve for some time.
Economists rightly see the next move as most likely being a rate cut after a period of pause. Bond traders, misled by the experiences of 2022 and wrongly assuming the world never changes, are expecting the next move to be a rate increase. Yesterday's June US consumer price inflation data rather supports the position of the economists, not because the headline was lower than expected as that is all about oil and will very possibly reverse as Trump's gulf policy changes again.
It is the detail and the absence of second round inflation effects in that detail that should reassure the Fed of a benign inflation outlook. It is however worth noting that the response rate for the consumer price inflation measure means that the data now only captures about two thirds of the targeted prices, down from capturing about 80% of the targeted prices before the pandemic. Consumer price inflation is not as good quality data as it used to be.
China's second quarter GDP slowed a little bit more than had been expected and 4.3% growth is indeed below the official target range. There have been reports that pressure has been applied to regional governments to be more precise in how they report growth figures, so some of this slowdown may not be an actual slowdown but instead is simply a better, more accurate reflection of reality after a period when reality and economic data were perhaps more loosely acquainted. The pattern is the same as it has been for some considerable time however.
Production data is generally fine because exports are generally fine. The domestic consumer remains a drag on activity. Retail sales data for June showed negative growth for many sectors with the more expensive items like autos and furniture being affected, although there apparently has been some enthusiasm for upgrading phones.
Today's calendar is in some ways an echo of what we had yesterday. We'll get a repeat testimony from Walsh and it's unlikely there'll be much of interest in that, but we also do hear from New York Fed President Williams who may offer more market relevant comments and is also perhaps less likely to be constrained by a horror of guiding markets as to what might happen next. There are also producer price figures from the United States, mercifully free from the fictional prices of owner's equivalent rent.
That's all for today. Have a good day. This material has been prepared and published by the Global Wealth Management Business of UBS Switzerland AG, regulated by FINMA in Switzerland.
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