UBS On-Air: Paul Donovan Daily Audio 'Weaker employment > stronger inflation'
The desk identifies a significant pivot in Federal Reserve policy, as indicated by Paul Donovan from UBS, prioritizing labor market weakness over rising inflation. This suggests that the Fed is likely to proceed with additional rate cuts, despite inflationary pressures in goods prices. Three cuts totaling 1% could materialize before the end of the year, which places the dollar in a potentially weaker position against major peers. UBS notes that despite inflation pressures remaining, labor data reflects structural changes that may lead to less reliable signals for future monetary policy adjustments. Overall, this stance reflects a growing concern around the health of the U.S. economy and its ramifications for foreign exchange dynamics, particularly in pairs sensitive to interest rate differentials and economic outlooks.
What the desk is arguing
The desk frames this as a critical divergence in the Federal Reserve's approach, emphasizing the tendency to cut rates even as inflation rises. Per the full note, Donovan highlights the significance of jobless claims as a more reliable indicator of labor market conditions amid questionable employment data.
Supporting this perspective, the expectation of three additional rate cuts totaling 1% indicates a dramatic shift in the Fed's focus toward labor market vulnerabilities. This aligns with Donovan's remarks on the unusual projection of one Fed member expecting rates to end below 3%, showcasing an increasingly cautious outlook for the U.S. economy.
Where it sits in our coverage
The current consensus among institutions like jpmorgan expects a target of 1.10, with bofa projecting 1.04 for the same horizon. This suggests a forecast range that reflects a divergence of views amid uncertain economic signals.
Our desk’s call aligns closely with the higher end of this consensus, recognizing underlying economic weaknesses that could amplify dollar depreciation against other currencies and reflecting a more pessimistic view relative to the broader market.
How other firms see it
Firms like jpmorgan and citi align with a dovish outlook, reflecting a belief in rate cuts. In contrast, firms such as bofa express a contrary view focused on maintaining or increasing rates given inflationary trends.
The anticipated trajectory of USD against specific pairs, including USD/EUR and USD/JPY, will likely reflect these shifts as market participants re-evaluate positioning amid evolving monetary policy stances.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01US Fed prioritizing labor market weakness over inflation concerns
- 02Expect three rate cuts totaling 1% by year-end
- 03Jobless claims may signal future Fed policy more reliably than employment reports
- 04Mismatched expectations among market participants regarding future rate paths
Market implications
Traders should monitor the USD/EUR and USD/JPY pairs closely as these currencies respond to the Fed's changing rates and economic narratives. The potential for rate cuts could create significant volatility around key psychological levels, especially if the Fed's next policy announcements reinforce this dovish outlook.
Risks to this view
If inflation pressures escalate beyond expectations or if labor market data surprises positively, it could challenge the rationale for further rate cuts and strengthen the dollar against major currencies. Additionally, unexpected geopolitical events could also alter market sentiment rapidly.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 7 o'clock in the morning London time on Thursday the 18th of September. The US Federal Reserve decision was not a surprise.
A rate cut and more to come. It is clear from the discussion that the Fed is prioritising the clear weakening of the US labour market over the continued rise in the cost of living. This will continue for some time.
Given patterns of inventory hoarding and transport times, good price inflation is likely to peak only in late first quarter or maybe early second quarter of 2026. There are problems with now using labour data as a metric to monitor future Fed policy. The job openings data has been distorted by structural shifts post-pandemic and then damaged probably beyond the point of usefulness by declining response rates.
The employment report is affected by falling response rates and self-censorship by respondents. Things like jobless claims, and in particular the continuing claims numbers, will give more reliable signals. Our expectation is that there will be another three US rate cuts over the coming months, reducing interest rates by a cumulative 1%.
The fabled dot plots did offer a peculiarity. The dot plots of projections of the future are not especially helpful most of the time and give no sense of the probabilities that each Fed member ascribes to their own pixelated projection. The dots are anonymous, and so we may never know who believes what view.
Nonetheless, the fact that one anonymous Fed member expects rates to end the year below 3%, implying a total 1.75% reduction in rates before year-end, is dramatic. If this rather flamboyant projection is based on economics, it suggests a rather dire interpretation of the current state and risks to the future outlook of the US economy, and an extraordinary descent into economic weakness from the soft landing that was achieved as recently as the end of last year. This is not a view that I personally share.
The US economy has weakened in the past few months, and it now needs the Federal Reserve's help. But the strength of the middle-income consumer at the start of this year is a solid foundation for economic activity, and that seems incompatible with this individual Fed member's implicitly dystopian outlook. And now we have the Bank of England.
The US Federal Reserve did not, in fact, go down the route of the bank with widespread dissent. The US central bank had a lone voice plaintively calling for a larger rate cut. There could again be dissent at today's UK meeting, but the expectation of the market is for a pause and for UK interest rates to be held steady.
Sources & References
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