UBS On-Air: Paul Donovan Daily Audio 'Prices palooza'
The desk argues that the US central bank's current reliance on individual consumer price data is problematic, suggesting that single data points should not dictate policy expectations. Per the full note from UBS, Paul Donovan highlights the disparity between the Fed's communication quality and market reaction to inflation data, indicating that today's consumer price metrics will significantly influence the outlook for interest rates. With bond market dynamics shifting due to rising crude oil prices, traders should be prepared for volatility, particularly as a critical Fed meeting approaches. These factors coincide with broader disinflationary trends suggested by mixed producer price data, fueling speculation about future rate hikes.
What the desk is arguing
The desk posits that the market's dependence on singular US consumer price figures for monetary policy guidance underscores a lack of robust leadership at the Federal Reserve. Paul Donovan of UBS critiques this trend, noting that the forthcoming CPI release will heavily sway expectations for September's FOMC meeting. Specifically, should this data not trigger a rate hike, it could solidify a more dovish outlook for the remainder of 2023, as subsequent data is expected to show disinflationary pressures.
Supporting this thesis, Donovan points to recent producer price data, which showed marginally weaker headlines but stronger details used for personal consumption expenditures. He portrays a scenario where today's CPI could either confirm or thwart a September rate increase, fundamentally shaping the Fed’s narrative for the rest of the year.
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Key takeaways
- 01Dependence on individual US inflation data highlights leadership flaws at the Fed.
- 02Mixed signals from producer prices suggest a complex inflation landscape.
- 03Market reaction to CPI will impact rate hike expectations significantly.
Market implications
Watch for the US CPI release to dictate market direction as it approaches the pivotal September Fed meeting. Traders should prepare for volatility ahead of this critical data point, particularly in bond markets where rising yields have begun to impact sentiment.
Risks to this view
Should the CPI data come in unexpectedly high, it may prompt an immediate policy shift from the Fed, invalidating the current dovish outlook. Conversely, a significantly low reading might reinforce market expectations for continued easing, altering the trajectory of the USD.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning, London time, on Friday the 11th of September. The key focus for markets today is the US consumer price inflation data.
It is a sad reflection on the state of leadership at the US central bank that expectations about the next interest rate move are so dependent upon this single data release. Today's data may be revised, and its accuracy is certainly something that can be questioned. And yet, such as the quality of US Federal Reserve Chair Walsh's communications, the market's expectation for policy for the remainder of this year rests on this solitary data set.
Yesterday's producer price inflation data in the States was mixed. The headlines were very marginally weaker than had been expected, but the details that are used to calculate the personal consumer expenditure deflator were a little stronger. If today's number does avoid a rate increase at the September FOMC meeting, then a rate hike seems unlikely for the remainder of this year, because subsequent data will tend to be mildly disinflationary.
If today's number provokes a rate increase, then a second rate hike seems likely, to prove that the first was not a mistake. The mistake would then be corrected later in 2027. One thing that might weigh on policy decision-making is the performance of the bond market.
Markets are now starting to react to inflation concerns, it would seem. The rise in crude oil prices to over $107 a barrel seemed to unnerve bond investors yesterday, pushing yields higher. US gasoline and diesel prices have continued to move up rapidly.
In the past, there has been a hope that the negative political consequences of higher gasoline prices might encourage a US retreat in the Gulf. However, with US President Trump's approval ratings as low as they are, markets seem to be assuming a certain fatalism within the administration ahead of the midterm elections. As expectations around the power of voter opinion have faded, the optimism bias that was a market feature earlier in the conflict has been somewhat battered.
US Treasury Secretary House Bennet's bond-buying programme has not proved to be a terribly effective remedy. Bond markets are also inclined to price in further European interest rate increases in the wake of another policy error yesterday. It's not so much the rate hike yesterday, which was expected, as the hawkish set of forecasts for inflation that have encouraged the market move.
However, bond markets are now pricing in a number of rate hikes that, if enacted, would at least raise the possibility of a recession in the non-oil economy of Europe, and would certainly induce an economic slowdown. It seems unlikely that the ECB would go that far, although another hike does seem more likely now. One more hike is a gesture that does not do that much to growth or inflation, but it allows the ECB to declare, look, we're doing something.
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