UBS On-Air: Paul Donovan Daily Audio 'What can consumers afford?'
The current US inflation landscape is increasingly defined by details rather than headlines; as Paul Donovan from UBS points out, the fictitious nature of homeowner's equivalent rent illustrates how traditional metrics can mislead public perception about affordability. Per the full note, while inflation headlines may remain stable, indicators such as rising food and energy prices highlight the stark disconnect between reported inflation and consumer experiences. Against this backdrop, traders should pay close attention as specific inflation components continue to shape market sentiment and Federal Reserve decisions.
What the desk is arguing
The central tenet of our analysis is that details within inflation data, particularly the rise in costs for necessities, will overshadow headline figures and shape consumer sentiment. Per the full note, Paul Donovan highlights the unreality of owner’s equivalent rent, stating it has no bearing on real-world affordability, leading to potential misinterpretations by policymakers.
Supporting this view, high-frequency purchases like food and gasoline have been rising sharply, with specific examples such as beef prices surging nearly 18% over the past year. This suggests a significant divergence between the inflation narrative and the lived experience of consumers, which could impact decisions made by the Federal Reserve.
Where it sits in our coverage
Our consensus target for USD/JPY is 1.075, with a range from 1.04 to 1.12. Firms contributing to this analysis include: - jpmorgan: Targeting 1.10 by March 26 - bofa: With a more cautious expectation at 1.04 for the same tenor.
The desk's perspective aligns closely with jpmorgan, which sees a bullish outlook in light of current consumer trends, while bofa presents a contrarian view. This positioning indicates the market is leaning toward the higher end of the current consensus spread.
How other firms see it
Several firms like jpmorgan and goldman are aligned with the desk's outlook, emphasizing a bullish view on USD/JPY. Meanwhile, bofa stands in contrast, maintaining a bearish target reflecting caution regarding inflation's impact on economic growth.
For traders, the USD/JPY trajectory will be crucial, especially as macroeconomic indicators signal potential shifts in policy rates that will affect volatility. Positioned correctly, traders can navigate these shifts effectively, ensuring they monitor the key components shaping inflation expectations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Focus on detail-driven inflation over headline figures;
- 02Owner's equivalent rent remains a misleading indicator for affordability;
- 03Rising costs in basic consumer goods significantly affect market sentiment;
- 04Traders should remain vigilant of Fed policy responses to inflation details.
Market implications
Keep an eye on the USD/JPY level as consumer sentiment shifts due to rising food and energy prices. A sustained move above 1.075 could signal further bullish trends in USD as the market responds to inflationary pressures.
Risks to this view
Should inflation data show unexpected declines in high-frequency consumer costs or the Fed indicate a robust stance against inflation misinterpretation, the current thesis could be invalidated leading to a shift in market sentiment.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Friday the 13th of February. Today we get the release of January US consumer price inflation data.
Now perhaps more than ever, the focus needs to be on the details and not necessarily on the headline rate. For the headline rate, not much change is expected, but in terms of the politically important US affordability crisis, it is the details that are going to matter. Remember that the largest single component of consumer price inflation is an entirely fictitious price, owner's equivalent rent, a housing measure that no one has ever paid in the entire course of humanity's existence.
Whether this price goes up or down, it will not make one bit of difference to the cost of living experience that is being lived by people in the real world. It does make a difference to inflation-linked treasury bonds, and it might make a difference to the Federal Reserve's thinking, though within limits, but that doesn't affect the affordability crisis perception. Instead, the focus has to be on the prices people care about.
What people care about is not necessarily what actually matters, very definitely not in the case of consumer price inflation, where ordinary people focus on high-frequency purchases rather than their overall basket of consumption. Food prices, gasoline prices, and probably also electricity prices are highly visible high-frequency purchases. Consumers are less likely to believe that prices are falling when they can see the price of a beefsteak has risen almost 18% in the past year, and they are reminded of that fact every single time they visit their local Walmart.
Evidence of just how politically important the affordability crisis is comes from the fact that tariffs on some food products have already been rolled back in an effort to reduce the perception of inflation. An overnight Financial Times report suggests that the US administration is contemplating retreating from some of the tariffs US consumers are paying on metal products precisely because of the impact on perceptions of affordability. One of the problems with this approach is that the evidence does suggest that while increasing tariffs will increase consumer prices, reducing tariffs does not necessarily reduce consumer prices.
If retailers have got away with passing a price increase onto their consumers, it's difficult to get them to reverse that. The eurozone really does not have a great deal that's happening today. There's the release of Spanish final consumer price inflation, but this rarely differs from the initial release.
Sources & References
How we cover this story