What's takeaway 1 on UBS On?

Market optimism surrounding US withdrawal may overlook Iranian dominance over shipping costs.

What's takeaway 2 on UBS On?

Higher prices from Hormuz tolls are likely to impact global supply chains and inflation.

What are the market implications for UBS On?

Traders should closely monitor the oil price responses, particularly as elevated shipping costs could reshape market dynamics. Watching the EUR/USD take shape during this geopolitical transition will be crucial, especially in correlation with oil price movements as central banks adjust for inflationary pressures.

What are the risks to this view on UBS On?

Any sudden escalation in military conflict or UN-sanctioned interventions could radically shift the current landscape, leading to substantial changes in oil supply routes and pricing mechanisms. A reversal in US policy, especially if accompanied by renewed international coalition actions, would invalidate the current bullish sentiment.

UBS On-Air: Paul Donovan Daily Audio 'Tariffing Hormuz traffic?'

What the desk is arguing

The desk posits that the potential US withdrawal from the Gulf could deflate direct military involvement while elevating Iranian leverage over shipping routes in the Strait of Hormuz. The optimism observed in futures markets may be misplaced as investors might ignore the subsequent economic ramifications of an Iranian 'toll' for passage, affecting oil prices and trade flows.

Paul Donovan's analysis indicates that while the market is buoyed by the prospect of reduced US military engagement, it fails to account for the potential for increased costs in oil supply chains. Specifically, the notion of Gulf countries encountering elevated oil prices due to a toll regime raises concerns about inflationary pressures on the global economy.

Where it sits in our coverage

Our consensus target for relevant currency pairs is positioned at 1.075, encompassing a range between 1.04 and 1.12. Specific targets from notable firms include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)

This viewpoint is somewhat aligned with jpmorgan, which emphasizes stable pricing in light of geopolitical tensions, although the outlook diverges from bofa, which forecasts more conservative figures based on potential economic fallout from increased geopolitical risks.

Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Tuesday the 31st of March.

Investors seem to be quietly humming Monty Python's, Always look on the bright side of life. A report in the Wall Street Journal suggests that US President Trump is contemplating a retreat from the Gulf War, with Iran still in control of the Strait of Hormuz. Futures markets have reacted with cautious optimism to the idea of a US withdrawal and seem content to put to one side the issue of Iranian control of Hormuz, something that would presumably lead to taxes on shipping passing through it, a bit like US tariffs but for imports and exports to and from the region.

This may end up being the middle way, physical supply resuming, with a lag because of damage to infrastructure etc, but with a higher price for oil coming out of the Gulf to reflect an Hormuz toll. Iran appears to have successfully hit a fully laden oil tanker off the coast of Dubai, which is a reminder that there is more than one side to a war. The US White House press spokesperson has said that the United States might ask countries in the Gulf to pay for the war.

The cost to US taxpayers so far has been quite sizeable and that is something that may be a focus ahead of the US mid-term elections. However, the idea that Gulf countries will be eager to pay for a war they were not consulted about at the same time as they have to pay for reconstructing damaged infrastructure, rearming and expanding defence capabilities and attempting to resuscitate the non-oil sectors of their economies might be quite a challenge. Economically, the question is whether Gulf countries will direct their military budgets towards buying US-manufactured weaponry, or whether this experience might pivot their purchases elsewhere, as has been the case with European defence procurement for instance.

That would mean that petrodollars would be increasingly recycled into other currencies. German inflation data yesterday showed the expected impact of the war on spending power with the headline consumer price reading ticking up. The damage may be less than the headline actually suggests as consumption patterns adjust, but there is certainly damage being done.

Japan's March Tokyo inflation data did not show the same effect, as government subsidies for electricity and gas have muted the impact there. As those subsidies fade – they're set to halve in the April data – the cost of war will become more apparent to the Japanese consumer. The government of South Korea, which has already imposed an energy price cap, is set to put in place another budget to subsidise energy prices still further.

This action avoids the economic pain now, assuming there's no physical shortages of oil, but it does not motivate consumers to be more efficient in their energy use and it obviously comes at a fiscal cost for the future. Euro area preliminary March consumer price inflation data is set for release today. Comments from US Federal Reserve Chair Powell and New York Federal Reserve President Williams have caused bond traders to become reacquainted with the real world.

The signals from Fed speakers were that policy was going to stay where it is for now, and the idea of rate increases is not particularly plausible. Bond traders had forgotten that, for the most part, economists and not social media memes determine policy, and they'd been pricing in rate increases in the States. One of the concerns highlighted by Williams was the conflicting signals that are coming from the US labour market.

We get the job openings data today, which would be useful information if it were credible, but the astonishingly low survey response rate and the structural distortions caused by the pandemic aftermath have rather shattered the credibility of these numbers. 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. It's subsidiaries, or affiliates, are collectively referred to as UBS. In the USA, UBS Financial Services Inc. is a subsidiary of UBS AG and a member of FINRA SIPC.

The investment views have been prepared in accordance with legal requirements designed to promote the independence of investment research. This material is for your information only, and it is not intended as an offer or a solicitation of an offer to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal investment recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient.

This material may not be reproduced or copies circulated without prior authority of UBS. Please visit www.ubs.com forward slash CIO hyphen disclaimer to read the full legal disclaimer applicable to this material.

Institutional FX coverage in your inbox

UBS On-Air: Paul Donovan Daily Audio 'Tariffing Hormuz traffic?'

What the desk is arguing

Where it sits in our coverage

Sources & References

Primary source