UBS On-Air: Paul Donovan Daily Audio 'Up we go again'
The recent spike in crude oil prices, with Brent crossing $110 per barrel amid geopolitical tensions, signals a potentially volatile landscape for monetary policy. Per the full note from UBS's Paul Donovan, the ramifications of higher oil prices may compel the U.S. administration to reconsider its foreign policy stances, particularly regarding Iran and the ongoing sanctions. This evolving scenario brings to light the challenges central banks face in navigating inflation-related pressures—historically, four significant shocks like this have shifted the dynamics, yet few second-round effects have been realized. As such, exchange rate responses could shift based on market interpretations of these geopolitical risks and policy responses ahead, particularly with central bank meetings not currently on the horizon.
What the desk is arguing
The desk views the recent rise in oil prices as a pivotal moment that could dictate various economic outcomes. According to UBS, the sensitivity of U.S. markets to oil price fluctuations highlights a crucial nexus between geopolitical actions and economic measures, making this a critical juncture for traders.
Donovan notes that although inflation continues to loom large, the lack of second-round effects from previous shocks suggests underlying inflation stability. This informs a more nuanced approach, pushing traders to weigh geopolitical risks against potential economic policy shifts, which may manifest across various currency pairs.
Where it sits in our coverage
In our recent coverage, the consensus target for the EUR/USD is set at 1.075, ranging from 1.04 to 1.12, with notable targets from: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk's perspective aligns closely with jpmorgan, who also anticipates upward pressure in a similar price range due to oil dynamics and its global implications. Conversely, bofa holds a more cautious outlook, positioning themselves at the lower end of the spectrum.
How other firms see it
Other aligned firms like jpmorgan echo the sentiment of ongoing upward price pressure in the oil market, anticipating a correlated reaction in currency valuations. In contrast, firms like bofa remain skeptical about sustained upward movements, highlighting risks of potential recessionary measures.
The ongoing discussions surrounding U.S. foreign policy dynamics may create ripples across significant currency pairs like USD/JPY and EUR/USD, capturing market attentiveness as traders brace for potential shifts in sentiment and response strategies from central banks.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Geopolitical tensions are driving oil prices above $110 per barrel.
- 02Higher oil prices may influence U.S. political actions and monetary policies.
- 03Lack of second-round inflation effects suggests underlying stability despite shocks.
- 04Traders should closely monitor the interplay between oil prices and potential U.S. policy shifts.
Market implications
Traders should closely monitor the implications of oil price movement at critical levels, particularly the $110 mark, as it may influence monetary policy perspectives. This factor could lead to increased volatility in major currency pairs, especially USD/EUR, as the market reacts to both oil price dynamics and geopolitical developments.
Risks to this view
Should the U.S. administration opt for a substantial policy shift in response to rising oil prices, particularly engaging more positively with Iran, it might alter market perceptions dramatically. Similarly, if central banks pivot towards restrictive measures, recession fears could escalate, leading to a more pronounced market correction.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's six o'clock in the morning UK time on Wednesday the 21st of October.
Attacks on shipping in the Strait of Hormuz and concerns about the depletion of US oil reserves have helped to push the price of Brent crude oil above $110 a barrel. The price of oil is clearly something that motivates a political response in the United States. Hence US President Trump lifting Russian sanctions to try and lower the price of US diesel, a deal that has had no discernible effect as retail diesel prices remain just below their all-time highs.
The uncertainty for investors is less the inflation consequences, which are fairly obvious, and more the policy response. If the political climate caused by higher oil prices pushes Trump to make concessions to Iran, the outcome may be more positive for financial markets. If oil prices push central banks into restrictive policies, recession risks then rise.
One of the challenges for central banks is that although the oil price shock is a one-off effect beyond the control of central bank policy, it is the fourth such one-off price shock, and they're all beyond central bank control. The supply disruption post-pandemic was followed by Russian invasion of Ukraine, which was followed by tariffs, which was then followed by the Gulf War. None of this is about macro-driven supply-demand imbalances in the economy, which is what central banks can actually control, or at least influence.
With the exception of the profit-led inflation that took place in the wake of the supply chain disruption, there has been little or no evidence of second-round effects through all of this. That's actually a rather telling point for policy. Despite four successive inflation shocks, second-round effects have still not really emerged, and that suggests that underlying inflation pressures relating to the structure of the economy are benign.
The problem is we never get to see the underlying pressures because of the repeated shocks. With this backdrop, the UK has its consumer price inflation data release for September, along with producer price information as well. The UK is, of course, the fastest-growing G7 economy this year so far, which suggests consumer resilience and allows the Bank of England to consider raising interest rates.
The price of goods in stores has remained relatively contained, however. The British Retail Consortium's shop price index, for instance, has been boringly stable over the course of this year, running with a mild positive inflation rate of around 1.3% year-over-year. The UK does have a delayed and exaggerated oil price problem because of the weird way that UK electricity prices are calculated – not a price that contributes directly to the British Retail Consortium data, of course.
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