UBS On-Air: Paul Donovan Daily Audio 'To and fro'
The desk believes the current rhetoric from the Federal Reserve reflects deepening uncertainty about policy decisions, particularly with regard to the resilience of the US labor market and its implications for monetary policy. Per the full note source, Fed Governor Waller's gloomy commentary suggests that market participants are grappling with the likelihood of a rate cut in December, reflecting concerns about economic performance and consumer affordability. Concurrently, the tension between inflationary pressures, particularly those induced by tariffs, and the Fed's need to support employment results in a complex economic landscape. A focus on these dynamics indicates that traders should remain vigilant as inflation projections rise into early 2024, which could influence currency positioning and volatility.
What the desk is arguing
The desk argues that the Federal Reserve's internal debate over rate policy underscores significant macroeconomic uncertainty, particularly tied to labor market conditions and inflation trends. Donovan's commentary highlights that Fed officials like Waller exhibit a bearish tone, anticipating potential rate cuts while simultaneously confronting rising living costs driven by inflation. This complex balance of factors is likely to guide shaping expectations for monetary policy moving forward.
Analysts are increasingly fixating on employment statistics and inflation forecasts, with a notable risk highlighted by Donovan that inflation may be fueled by tariff-induced cost pressures in the coming months. Previously strong hiring has led to cautious optimism; however, uncertainty looms regarding firms’ willingness to hire amid potential economic instability.
The alternative read would suggest that if inflation can be contained and job growth remains stable, there could be less urgency for the Fed to cut rates, which would shift market expectations significantly. However, that assumption relies heavily on external factors that are currently unpredictable.
Where it sits in our coverage
Our consensus target for USD/EUR remains at 1.075, with a range spanning from 1.04 to 1.12. Notable firm targets include: - JPMorgan: 1.10 (Mar26) - BofA: 1.04 (Mar26)
The desk's view of heightened caution around US monetary policy aligns with the broader market consensus but remains cautious at the upper bounds of market forecasts, driven by its readings of labor market vulnerabilities highlighted in the recent Fed comments.
How other firms see it
Many firms are aligned with a cautious perspective on future US monetary policy, particularly those wary of inflation and employment metrics. Contrarily, firms expecting a more aggressive Fed response, or who advocate for stabilization rather than cautious easing, remain in the minority.
Traders should pay attention to the impacts of Fed rhetoric on related currency pairs like EUR/USD or AUD/USD, as positions may be adjusted based on anticipated changes in US policy direction resulting from economic indicators and central bank communications.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed officials show public division on policy direction amid labor market concerns.
- 02Potential December rate cut remains on the table due to economic vulnerabilities.
- 03Rising inflation driven by tariffs necessitates close monitoring of consumer affordability.
- 04Complexity in the economic outlook means volatility in FX markets is likely.
Market implications
Traders should watch closely for USD/EUR approaching the consensus zone of 1.075, as this may shift based on upcoming economic data, particularly surrounding employment releases and inflation reports. Adjustments to positioning could precede Fed announcements in December, heightening volatility as expectations evolve.
Risks to this view
Any substantial unexpected improvement in labor market data could deflate fears regarding rate cuts and stabilize market expectations, leading to a stronger USD. Alternatively, significant inflation readings could prompt more aggressive action from the Fed, changing the trajectory of market sentiment entirely.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 5.30 in the morning London time on Tuesday the 18th of November. The latest round of commentary from officials at the US Federal Reserve is not really changing the uncertainty around policy decisions.
There is a faction at the Fed worried about the brittleness of the US labour market and prioritising that as a reason to cut rates, less as a stimulus measure and more as an insurance against any shattering of labour market expectations. Fed Governor Waller was sounding quite bleak about the labour market outlook and the performance of the US economy generally yesterday. At the same time, the cost of living, or in a broader sense affordability, has been rising up the political agenda.
With inflation perceptions rising, that is something other members of the Fed are focused on. Vice Chair Jefferson urging caution on rate cuts, implying a slower pace of future easing, alongside an acknowledgement of the well-established idea that firms are reluctant to hire because of policy uncertainty. This to-and-fro language around rates is likely to continue as the Fed shows an uncharacteristically public division of opinion on policy direction, reflecting in turn an unusually complicated economic outlook.
Inflation in the States is set to rise further into the first quarter, with lagged effects from tariffs adding to the headline consumer price index. Indeed, there may be an incentive for firms to pass through tariff costs earlier than they actually need to, if firms believe that the US administration will respond to any subsequent rise in inflation perceptions with further tariff cuts, as has been happening with tariffs on selected US food imports. However, if the inflation is seen as primarily tariff-induced, it should be temporary and the focus will be on keeping the fear of unemployment contained in order to support consumer spending.
If, however, second-round effects, in particular profit-led inflation, start to come through, then worries about transitory inflation numbers being extended and potentially boosted by a second wave may grow amongst Federal Reserve policy makers. Political tensions between China and Japan are moving into the area of economic policy. China accounts for about a quarter of all tourists into Japan – by numbers, not necessarily by spending power – and the government in Beijing has issued a warning to its nationals about travel to the country.
There have been references in China's media to possible further economic action, although there are also diplomatic efforts to calm the situation. At this stage, this is not something that seems likely to be market-significant, as the actual disruption to the Japanese and Chinese economies is likely to be limited. But it does have the potential to be more serious, so the rhetoric is still something of a market focus.
Official US economic data is now starting to come out and unofficial data continues to be released. The NAHB Housing Index, which is unofficial, is scheduled for November. There is also the possibility of factory orders data and durable goods orders data, which being official numbers, will have been delayed and would relate back to August.
August was rather a while ago, and the durable goods orders data is a revision of an earlier release, so market responses are still likely to be quite muted. That's all for today. Have a good day.
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