UBS On-Air: Paul Donovan Daily Audio 'Shifting expectations'

Paul Donovan · UBS Global Wealth Management

Germany's economy is better than the pessimistic narrative suggests, given initial data is revised up.

German manufacturing orders rose as expected in September, and the prior data was revised stronger, as is almost always the case. This tendency for initial German releases to be revised higher matters because pessimistic first prints feed a narrative that is more negative than the economy deserves. Germany is not doing badly, especially given its declining population. The implication is that the prevailing pessimism about Germany rests on flawed early data.

“And the narrative around Germany tends to be far more pessimistic than the economy actually deserves. Germany's not doing badly, especially considering it has a declining population.”at 2:05

Paul Donovan · UBS Global Wealth Management

Euro area energy-driven inflation is unlikely to produce second-round effects, since labour dilutes energy in CPI.

Euro area consumer and producer price data are still dominated by oil prices and base effects. Producer prices are more affected by energy than consumer prices, because consumer prices have a much higher labour content that dilutes the energy effect. Labour costs make up a majority of the consumer price calculation for almost every product. As a result, the data will not show evidence of second-round inflation effects emerging. Some further energy-cost pressure may come, but that depends on what happens in the Gulf.

“Producer price inflation is more affected by this than is consumer price inflation because consumer prices have a far higher labor content and that dilutes the energy effect more significantly... it is unlikely that there'll be any evidence of second round inflation effects emerging.”at 2:45

Paul Donovan · UBS Global Wealth Management

Midterm gridlock doesn't fix the US fiscal position but stops politicians from making it worse.

Financial markets have decided they approve of the US midterm results because they signal policy gridlock. Gridlock does nothing to solve the unsustainable US fiscal position, unless one believes in a productivity miracle that no sensible investor finds credible. However, gridlock stops politicians from making the fiscal position worse, which is always welcome. The argument is that gridlock limits further fiscal damage rather than improving the underlying debt problem.

“Gridlock, of course, does nothing to solve the unsustainable fiscal position of The United States unless one believes in the magic of the productivity pixie, which no sensible investor gives credibility to. However, gridlock stops politicians from making things worse”at 0:21

Paul Donovan · UBS Global Wealth Management

Oil's plunge reflects expectations of a US retreat from the Gulf war, not just optimism bias.

Oil prices plunged, and the move is more than optimism bias, though optimism bias is still present. Rather, it reflects expectations of a US retreat from its current position in the Gulf war. Vice President Vance issued a statement blaming Republican midterm losses on the war, and Trump appeared to endorse that statement. Oil prices moved sharply below $100 a barrel. The mechanism is that the perceived shift in US policy toward retreat lowered the expected path of the conflict and so pushed oil lower.

“On top of that, oil prices have plunged. This is more than the optimism bias, although the optimism bias is, of course, still there. Rather, it is in expectation of a U. S. Retreat from its current position.”at 0:42

Paul Donovan · UBS Global Wealth Management

Fed chair's belief that AI will lift productivity is a 'productivity pixie' story Donovan doubts.

Productivity data is unreliable, heavily affected by economic data uncertainty and often wrong, so it is not a solid signal. The Federal Reserve chair has signalled a belief that AI, described as a shiny new toy, will lift productivity. Donovan treats this as magic pixie dust rather than a sound basis for policy. Other economists are sceptical. Donovan's stance is that the claim is not credible, although he notes that because the chair holds the belief, the numbers still need to be watched.

“Because the one thing that U. S. Federal Reserve Chair Walsh has signaled about the future is a belief in the productivity pixie, scattering clouds of magic pixie dust from the shiny new toy that is artificial intelligence. Other economists are sceptical.”at 3:55