UBS On-Air: Paul Donovan Daily Audio 'What was Warsh thinking?'
The desk interprets the recent commentary from UBS, specifically the insights of Chief Economist Paul Donovan, as indicative of a cautious Federal Reserve narrative amid rising inflation concerns. With Fed Chair Warsh maintaining the status quo on interest rates while addressing multiple stakeholders, the message appears nuanced, hinting at an acknowledgment of bond market dynamics in light of inflation pressures. Per the full note from UBS, Warsh's communication strategy reflects not only market expectations but also the pressures from the White House, which complicates the Fed's policy setting. Given this context, the market is likely to react sensitively to any shifts in economic data or Fed rhetoric, which could challenge current positioning dynamics.
What the desk is arguing
The cable markets are currently reflecting heightened sensitivity to Federal Reserve communications, especially following Warsh's recent statements regarding inflation and interest rates. Donovan highlights the tendency towards dovishness, with the Fed seemingly deferring to the bond market's performance as an operative guide. Notably, three dissenting votes for a rate hike signal growing internal friction within the Fed's ranks, suggesting a need for careful navigation in policy messaging while addressing inflation concerns.
Furthermore, the focus on household perceptions about the Fed's inflation target reflects a disconnect between policymakers and public understanding, feeding into the narrative that the Fed must effectively communicate its goals if it hopes to regain credibility. This environment could support the dollar unless inflation data points begin to worsen, compelling the Fed to adjust its stance rapidly.
Where it sits in our coverage
Our current consensus target for USD/JPY sits at 1.075, with a range from 1.04 to 1.12. Specific firms providing insights include: - jpmorgan: 1.10 by Mar26 - bofa: 1.04 by Mar26
The desk's analysis aligns closely with jpmorgan, suggesting a positioning toward the upper bound of forecasts as investor focus shifts to inflation adjustments, while diverging slightly from bofa's more cautious outlook.
How other firms see it
The consensus among aligned firms such as jpmorgan indicates a bearish stance on the USD amid a dovish Fed narrative, while bofa takes a more cautious view, reflecting potential downturns in economic data. The sensitivities in the USD/JPY market could mirror broader reactions to Fed statements and upcoming inflation prints, impacting strategies across the board.
What the calendar says
Currently, no high-impact events are on the calendar, but any sudden shifts in economic data releases could prompt significant market reactions, particularly in USD/JPY as traders assess the implications for Fed policy direction and consumer inflation dynamics.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed remains cautious while facing inflation pressures.
- 02Market sensitive to Fed communications and inflation data.
- 03Dissent in Fed signals growing rifts in policy views.
- 04Household perceptions of the Fed's role in inflation are highlighted.
Market implications
Traders should keep a close watch on USD/JPY levels around 1.075, as shifts in sentiment can lead to significant volatility. Any future Fed communications or inflation data could further influence positioning ahead of potential rate adjustments.
Risks to this view
A notable turnaround in inflation data could prompt the Fed to pivot towards tighter policy, destabilizing current market positions. Additionally, unexpected comments from Fed officials may generate immediate volatility, reconsidering the market's outlook on interest rate trajectories.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning, London time, on Thursday the 30th of July. Yesterday's US Federal Reserve meeting left rates and the accompanying policy statement – if around 130 words merit the term statement – unchanged.
The three dissents in favour of a rate increase would have been a strong signal a few years ago. Today, they're more likely to reflect the culture of rebellion that has been building in recent meetings. At the press conference, Walsh appeared to be speaking to several audiences at once.
Suggesting that the Fed was accountable for inflation and that inflation would come down appeals very much to an audience of one – US President Trump. If the Fed is accountable for inflation, it cannot be Trump's fault. Unfortunately for the administration, the latest polls have only 25% of Republicans approving of Trump's management of inflation and Trump's overall approval ratings match record lows.
Walsh directed comments towards US households, talking about household perceptions of the Fed's inflation target. Polls suggest that a sizeable majority of US households do not know the Federal Reserve is supposed to target inflation at all. There were some reassuring comments, presumably aimed at markets.
The productivity pixie that was supposed to magic inflation away was much less in evidence. There was more acknowledgement that the Fed's balance sheet, maybe, is not an immediate problem. And that at least suggests a willingness on the part of Walsh to listen to experts on technical issues.
There was dovishness in the press conference, with Walsh clearly saying the bond market was doing the Fed's job for it, and it was giving cleaner signals by reacting just to data. In reality, Walsh's apparently deliberate fog of confusion around the policy framework means that the bond market is now more sensitive to Fed speeches, such as that of Warren recently. Equities were initially helped by the press conference, but the bond market was much less enamoured.
There was a sharp sell-off in the 30-year bond. This may not be about inflation expectations entirely. There is a risk premium that now has to be added to the real cost of borrowing in the US, because Walsh is removing the safety rails and letting bond investors indulge in whatever flights of fancy their imagination leads them towards.
This uncertainty raises real rates via the risk, and despite Walsh seemingly approving of higher real rates, unnecessarily raising the real cost of capital in an economy generally has long-term negative economic consequences. We get the Bank of England policy decision today. Like the Fed, the Bank of England is divided.
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