UBS On-Air: Paul Donovan Daily Audio 'The lesser of two evils'
The desk interprets recent Federal Reserve actions as a calculated step to counteract political interference, positioning the dollar favorably as the Fed is likely to implement further rate hikes. Per the full note from UBS, the unanimous vote for a rate increase serves as a sign of defiance against external pressure, hinting at the Fed's desire to appear resolute in its decisions. This context suggests that the market may adjust accordingly, particularly in the USD/JPY pair, as the interest rate differential becomes a decisive factor in currency valuations. As we await further developments on the monetary policy front, the upcoming Bank of England decision will be a critical space to watch for broader implications on FX positioning.
What the desk is arguing
The latest Federal Reserve rate hike reflects an intention to counteract political pressures rather than a robust economic foundation. Per the UBS commentary, the Fed's unanimous decision appears more as a show of strength in light of political influence rather than an economically sound strategy, indicating that a second rate increase may be forthcoming to reinforce that the first hike was intentional.
This rate increase could weaken the Japanese yen against the dollar, as the commentary suggests the fundamentals favor a stronger dollar, driven by interest rate differentials. In particular, the Fed aims to mitigate miscommunication issues, which could help the market retain confidence in the Fed's credibility.
Where it sits in our coverage
Currently, our consensus target for USD/JPY is 1.075, with a range between 1.04 and 1.12. Notably, jpmorgan forecasts a target of 1.10 for March 2026, while bofa holds a contrary view with a target set at 1.04.
This view aligns with the broader sentiment that the Fed's actions will yield a weaker yen. The desk's expectation sits comfortably near the higher end of the range discussion, suggesting room for potential gains in dollar valuation.
How other firms see it
The majority stance sees alignment with firms like jpmorgan and others anticipating a bearish yen trajectory, while bofa offers a divergent perspective, skeptical about the sustainability of dollar strength against the yen.
Keep an eye on USD/JPY, as well as potential shifts from the upcoming Bank of England decision. These central bank movements will play a crucial role in shaping the FX landscape and may generate volatility in pair valuations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The Fed's recent hike reflects a defiance against political interferences.
- 02Further rate hikes are expected to reaffirm the Fed's initial decision.
- 03Interest differentials are likely to favor a weaker yen against the dollar.
- 04The market's perception of the Fed's credibility will be critical moving forward.
Market implications
Watch USD/JPY closely, particularly considering fundamental shifts in interest rate differentials that could strengthen the dollar. The upcoming Bank of England decision may serve as a significant catalyst that influences broader FX positions, especially regarding G10 currencies.
Risks to this view
A reversal of this bullish dollar call may occur if inflation indicators do not support further rate hikes, or if political pressures lead to a significant shift in Fed policy. Additionally, a sudden change in global economic sentiment could impact interest rate expectations and alter the dollar's trajectory.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Thursday the 17th of September. Politics would seem to have some influence at the US central bank, just not in the way that US President Trump would wish it.
It is hard to read the unanimous vote in favour of a US rate hike as being anything other than a gesture of defiance at political interference. It seems unlikely that everybody on the Federal Open Market Committee is behind the decision with quite that implied level of conviction, as the rate increase rests on rather wobbly foundations. Of course, this choice was the lesser of two evils.
Economically, unchanged rates could be justified, but the mismanagement of Federal Reserve communication would have led to an unfortunate interpretation of such a decision with negative consequences. However, having bowed to the leadership of the market, the Fed will almost certainly have to do a second rate hike in order to prove that the first hike was not an economic mistake. The first hike was an economic mistake and will do nothing to change inflation, but it's important to pretend that it was not a mistake.
The Fed's decision is something of a challenge for US Treasury Secretary House Besant. The move has not significantly changed bond yields. The 10-year yield signals a certain contempt for the recent bond buying programme the US Treasury put in place.
The shift in fundamentals, in this instance the interest rate differential, weakened the yen against the dollar. In the long term, fundamentals will win out, which is why economists are always right and markets are just out of sync with our forecasts. If fundamentals dictate a weaker yen, currency intervention can only be a temporary interruption, no matter how loud the claims of inside knowledge.
The central bank fund does not stop with the US this week. Today, we have the UK's Bank of England decision. The expectation here is clearly for unchanged rates.
Markets are not bullying the Bank of England into tightening because investors know that there is little the bank can do about the weirdness of UK electricity pricing, for instance. Away from that, price pressures are not calling for a rush to raise rates. Of course, the Bank of England's Monetary Policy Committee is known for the independence of its members, and so there is more likely to be a range of opinions to express.
There's also no need to set up a united front against the perceptions of political interference. Over in the glittering wonder that is the euro, we hear from ECB chief economist Lane. There is speculation about what the ECB does next.
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