UBS On-Air: Paul Donovan Daily Audio 'The return of the armchair generals'
The recent military escalations in the Middle East are reshaping market dynamics, particularly in oil pricing and risk sentiment. As reported by Paul Donovan of UBS, Iran's targeted strikes on tankers in the Strait of Hormuz and the Houthi threats in the Red Sea are undermining confidence in U.S. military protection, resulting in rising oil futures. Given the potential fiscal stimulus from U.S. defense spending, including a projected budget of $95 billion for the Gulf region, traders may seek a more conciliatory U.S. stance to alleviate oil price pressures. Per the full note source, markets will likely remain cautious while watching the geopolitical responses from the U.S. and Iran.
What the desk is arguing
The desk posits that the ongoing military tensions in the Gulf are fostering uncertainty in oil markets, impacting not only oil prices but also broader FX movements. Donovan highlights the significance of successful Iranian attacks on shipping and the potential ramifications for U.S. policy, framing these developments as critical for investor sentiment.
Recent oil futures have climbed, indicating alarm among traders. The tight correlation between geopolitical risk and oil prices suggests that a continuation of these tensions will lead to sustained volatility in markets reliant on oil supply and stability. A reported 7% of global oil supply traverses the increasingly vulnerable Red Sea route, further emphasizing the high stakes involved.
Where it sits in our coverage
Our current consensus target for USD/IRR is 1.075, within a range of 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk's view aligns closely with jpmorgan while contrasting with bofa, which stands on the lower bound of the spread while our target is positioned near the upper range limit.
How other firms see it
Firms such as jpmorgan and credit suisse are anticipating increased volatility in oil-linked currencies due to geopolitical tensions. In contrast, bofa holds a more conservative stance, awaiting clearer signs of U.S. intervention. Currency pairs like USD/JPY may reflect these dynamics, aligning closely with the broader implications of oil price movements and military developments in the Gulf region.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Military tensions in the Gulf are affecting global oil supply and pricing.
- 02A $95 billion U.S. defense budget could inject momentum into the economy but also lead to higher oil prices.
- 03Investor sentiment hinges on the U.S. response to Iranian aggression in international waters.
Market implications
Watch for oil prices to influence USD/IRR dynamics, especially as geopolitical tensions evolve. A significant uptick in crude prices could signal further market volatility. Traders should also monitor U.S. statements regarding military responses that could affect overall market sentiment.
Risks to this view
A rapid de-escalation of tensions or a clear U.S. military intervention could significantly reverse these trends, potentially easing oil price pressures and stabilizing markets. Any diplomatic breakthroughs would also impact currency valuations linked to oil producers.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 6 o'clock in the morning London time on Thursday the 23rd of July. The escalation of military strikes in the Gulf has affected the oil price with crude futures rising further.
US President Trump's threats against Iran have not convinced markets that there will be a rapid conclusion to the current violence. Investors would seem to want to hear a more conciliatory tone as a prelude to US concessions in order to start reducing the oil price and oil price expectations. Successful strikes against oil tankers attempting to pass the Strait of Hormuz would seem to emphasise the Iranian control of the Strait at the moment, with US military cover not preventing the attacks and the attacks in turn not likely to encourage shipowner confidence.
Further attacks by the Houthi in the Red Sea have broadened concerns. From the very outset of the war, the Red Sea has been one of the major risk factors to global oil supply, with currently around 7% of global supply using the Red Sea route that now may be considered more vulnerable. Future attention is likely to continue to focus on the US reaction function rather than the Iranian.
The cost of the war to the United States is not just measured in the transfer of US household savings to oil producers. The US House of Representatives passed a budget for $95bn to finance the war in the Gulf. It may also potentially include funding for Defence Secretary Hegsketh's gender-affirming care plans, though that is not spelled out specifically.
This is a fiscal stimulus to the United States. It will be deficit-financed. However, it is also a fiscal stimulus to the global economy, as at least some of these funding plans are dependent upon imports.
Large quantities of testosterone, for instance, have traditionally been manufactured in Asia and in Europe. One thing to remember about defence spending is it does tend to be spread out over quite a long period of time. Replenishing missile stockpiles after the barrages against Iran could take up to two years in some cases.
So budgets passed by Congress today do not equate to real-world economic stimulus all at once. Against this backdrop, the European Central Bank meets. There is no expectation of a change in rates, nor is there an expectation for any apology for the past policy mistakes that the ECB made by raising rates when there are no inflation second-round effects.
Inflation has continued to come in marginally lower than expected in the European economy, and that is not likely to particularly change the policy outlook. The rising oil price will give the hawkish faction within the ECB an opportunity to sound hawkish again. This allows the Bundesbank faction to live in a fantasy world where a central banker can single-handedly bring peace to the Middle East, reopen the Strait of Hormuz, restore global oil flows and adjust prices in a single market with the merest hint of a rate increase.
In the real world, there is nothing central bankers can do about the oil price, and if there are no second-round effects in evidence, doing nothing is going to be the best policy strategy to adopt. The data calendar is pretty dull. There are some sentiment indicators floating around, and the weekly initial jobless claims data from the States as well.
But today is likely to be a day for armchair generals opining on military matters. 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, 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.
Sources & References
How we cover this story