UBS On-Air: Paul Donovan Daily Audio 'Real talk'
The desk interprets the forthcoming US consumer price inflation data as potentially misleading, particularly when considering that a material portion of the index reflects inflated housing costs not borne by average consumers. Per the full note from UBS, this results in a headline number that increasingly misrepresents economic realities, especially against a backdrop of rising income inequality and political factors influencing inflation expectations. Notably, the consensus forecast calls for only a marginal uptick in headline inflation in the coming report, yet a more localized view reveals that nearly half of metropolitan areas are experiencing lower inflation rates, indicating a divergence from widespread assumptions. The evolving landscape of consumer inflation sentiment reinforces a cautious stance on traditional metrics used to gauge spending power, which may be less applicable given these discrepancies.
What the desk is arguing
The desk posits that the upcoming US inflation data may significantly miscalculate the inflationary experience for average households. This premise stems from Paul Donovan's commentary at UBS, highlighting that a quarter of the housing index represents 'fantasy prices' that do not align with reality for most consumers.
Supporting this view, Donovan notes that nearly 50% of U.S. metropolitan areas reported inflation figures below 2.5% recently, contrary to broader assumptions of rising costs. When employing European measurement methods, actual inflation has been below 2% for six consecutive months, suggesting a need to reassess how inflation is perceived and reported.
Where it sits in our coverage
Our consensus target for the USD/EUR pair currently stands at 1.075, with a range between 1.04 and 1.12. Notably, jpmorgan has set a target of 1.10, while bofa is positioned more neutrally with a target of 1.04.
This narrative diverges slightly from the broader market consensus, particularly as bofa's lower stance contrasts with our upper-end expectations from jpmorgan. Our read captures the potential downsides lurking within the upcoming inflation data announcement.
How other firms see it
Several firms, including goldman and citi, share a more optimistic outlook on inflation trends ahead, anticipating faster recovery indicators. In contrast, bofa remains cautious, reflecting a belief in subdued overall price growth that echoes Donovan's concerns.
This discussion intersects with expected movements for the USD/EUR pair and could be influenced by the Federal Reserve's upcoming decisions on interest rates, as these measures directly correlate with inflation metrics and expectations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01US inflation data is misrepresentative due to inflated housing prices.
- 02Nearly half of U.S. metropolitan areas reported inflation below 2.5%.
- 03Income inequality is distorting average price representations for consumers.
- 04Consumer inflation expectations are increasingly political rather than economic.
Market implications
Traders should keep a close eye on the USD/EUR target range and position accordingly ahead of the inflation data release. A significant deviation in the numbers relative to expectations could trigger a market reaction, particularly if the outcomes align with the lower inflation experience of local areas.
Risks to this view
A reversal in this positioning could occur if the inflation data reports a significant increase, contradicting current expectations. Specifically, any unexpected acceleration in consumer prices could lead to a reevaluation of Federal Reserve policy and interest rate projections, impacting dollar valuation.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Wednesday the 11th of December. Today we get U.S. consumer price inflation data for November.
These numbers are a mess, basically. A quarter of the data is a fantasy price for housing that nobody ever pays. The growth of income inequality in the United States in recent years means that the headline inflation number is less and less representative of the experience of the median consumer.
And relative price changes mean that the overall picture of inflation pressures can be blurred by weird anomalies. Moreover, with the threat of consumer taxes from the incoming U.S. administration, and with the likelihood of second-round effects from those taxes, there is a potential structural break in inflation ahead. It's also worth reiterating that consumers' inflation expectations have become more and more divorced from reality.
In the past month, consumer inflation expectations have completely collapsed for Republicans and have soared for Democrats. Politics, not perception, is driving this. From the headline numbers today, the market consensus is for a very slight increase in the year-on-year headline rate and a stable core year-on-year rate.
Beneath the headlines, in the past two months, almost half of U.S. metropolitan areas have had inflation below 2.5%. If inflation is measured the European way, which ignores the fantasy housing measure, inflation has been below 2% for six months. These measures are not cherry-picking numbers to create a lower figure.
They really matter. These figures are a better reflection of the inflation reality for most U.S. households, and the inflation reality has been below 2% inflation. It also means that the real average earnings numbers published today can be ignored as they use an unreal inflation experience.
The lower actual inflation experience means that the spending power of those households is better than the headline consumer price inflation is suggesting. This is why the U.S. consumer has continued to be so supportive of the U.S. economy, and it's why the foundations of U.S. growth are relatively firm as we enter 2025. Japan had higher producer price inflation in November, with some upward revisions to the October numbers.
The price increases were focused on agricultural products and utilities, so that's not necessarily indicative of widespread pricing pressure. The manufacturing sector had lower inflation across pretty much all of its components, and indeed this was the second lowest manufacturing sector producer price inflation rate since the first quarter of 2021. It is a reminder that while the Bank of Japan will probably look to raise rates next year, the pace of rate increases is likely to be very carefully considered.
Sources & References
How we cover this story