UBS On-Air: Paul Donovan Daily Audio 'The policy-induced recession risk'
The desk emphasizes a looming risk of policy-induced recession as central banks grapple with rising crude and diesel prices. Per the full note from UBS, the interplay of these commodity prices suggests that monetary policy may have to shift aggressively towards restriction, challenging both equity and bond markets. With U.S. crude oil climbing over $80 per barrel, traders should be cautious as this inflationary pressure may compel the Fed and ECB to adopt a more hawkish stance sooner than expected, further complicating the risk landscape. Market consensus appears to reflect uncertainty about inflationary persistence, which could hold implications for currency pairs like EUR/USD and USD/JPY, considering their sensitivities to oil price movements.
What the desk is arguing
The desk highlights the significant risk of a recession induced by central bank policies aimed at curbing inflation from rising oil prices. This concern arises as crude and diesel prices surge, with last Friday's reserve releases generating further market ambiguity. Per the full note from UBS, investors fear that to counteract inflation stemming from oil prices, central banks may need to enact severe monetary restrictions, leading to possible downturns in equity and bond markets.
Support for this view is found in current market dynamics: crude oil prices have risen above $80 per barrel, reflecting investor concerns about supply stability amidst geopolitical tensions. This upward price movement could necessitate a reactive tightening by policymakers to restrain inflation, which in turn undermines the performance of both equities and bonds as indicated by market trends.
Where it sits in our coverage
Our consensus target for EUR/USD is 1.075, with a range between 1.04 and 1.12. Notable targets from analysts include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk positions itself near the upper end of this range, as concerns regarding inflation and central bank policy diverge from bofa's more bearish outlook, suggesting a possible rally in the near term.
How other firms see it
Aligned firms believe that rising commodity prices will lead to a more hawkish stance from central banks, affecting major currency pairs. In contrast, bofa takes a more cautious approach, betting on a potential easing of inflation pressures.
Related currency pairs to watch include EUR/USD and USD/JPY, which are likely to react to shifts in monetary policy and commodity price dynamics as this story unfolds.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The risk of a policy-induced recession rises as central banks confront higher oil prices.
- 02Crude oil has crossed $80/barrel, foreshadowing aggressive monetary tightening.
- 03Rising energy costs may lead to selling pressure in equities and bonds.
- 04Market consensus shows divergence in inflation expectations among firms.
Market implications
Monitor the EUR/USD performance, especially as it approaches the 1.075 level, which reflects the potential hawkish turn from central banks. Given the current oil price surge, traders should also keep an eye on the USD/JPY trajectory for sentiment shifts.
Risks to this view
A sudden reversal in oil prices due to geopolitical developments or OPEC interventions could invalidate the current bearish sentiment on equities and bonds, leading to a potential reassessment of central bank strategies and market reactions.
Crude oil prices and diesel prices are up (there seems to be uncertainty about whether last Friday’s pledge to release diesel reserves is actually just confirming previously announced reserve releases). Bonds and equities do not like this. Central banks have pretended that they can do something about oil prices, which worries investors.
If central banks want to offset inflation from an oil shock, they need to create a recession (or near recession) in the non-oil economy via aggressively restrictive policy. That does not favor bonds or equities.
Sources & References
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