UBS On-Air: Paul Donovan Daily Audio 'A tale of two markets'

Paul Donovan · UBS Global Wealth Management

Rising grocery and electricity prices will keep lifting inflation perceptions and affordability concerns.

Grocery and electricity prices are rising sharply and are likely to keep rising. These categories strongly influence how people perceive inflation. Because perceptions drive affordability judgements, the price rises are likely to keep pushing up affordability concerns, which in turn feed the midterm anger seen in exit polls.

“The sharp rise in grocery prices and electricity prices is likely to continue to boost inflation perceptions. And perceptions are what matters when it comes to determining affordability.”at 0:51

Paul Donovan · UBS Global Wealth Management

The narrative that AI demand is fuelling US inflation is not convincing at present.

Donovan rejects the idea that AI demand is a meaningful driver of current inflation. He gives no detailed evidence, but his broader argument is that inflation comes from a supply shock rather than surging demand, which implies AI is not the cause.

“Even the narrative of AI demand fuelling inflation is not terribly convincing at the moment.”at 2:52

Paul Donovan · UBS Global Wealth Management

Equities are ignoring inflation details that hint at problems for stocks ahead, while bonds look more worried.

Equity markets are so focused on AI that they have largely ignored the US consumer price inflation print. Bond markets, by contrast, reacted to the print and to Waller's comments. Donovan says the details of the CPI data, notably grocery and electricity prices, point to possible problems for equities ahead.

“Equity markets are so intensely focused on the shiny new toy of AI that they have been able to ignore much of The US consumer price inflation print. ... But the details of the consumer price data do hint at some possible problems for equities ahead.”at 0:17

Paul Donovan · UBS Global Wealth Management

Affordability worries could start to dent US consumer spending, though subtle hints are the only evidence so far.

Affordability concerns have not yet noticeably changed consumer behaviour, but there are very subtle hints that they might. Donovan says it would be foolish to bet against US consumers' willingness to spend, but the risk is fatigue from affordability pressures, which could eventually show up in real spending.

“there is a concern that this perception may actually start to impact real world consumer behaviour. ... But the risk has to be some sort of fatigue in the context of affordability.”at 1:17

Paul Donovan · UBS Global Wealth Management

Rising electricity prices suggest local hostility to data centre construction will persist; data centres paying for their own power could raise costs.

Electricity prices are rising, even if only on a seasonally adjusted basis. Donovan argues this makes public hostility to data centre construction unlikely to fade quickly. He adds that if data centres have to pay to power themselves as a matter of course, that potentially increases their costs.

“the rise in electricity prices, albeit only on a seasonally adjusted basis, suggests that hostility to data centre construction is not likely to fade terribly quickly.”at 1:45

Paul Donovan · UBS Global Wealth Management

A modest Fed rate increase will do little to curb inflation, since it stems from a supply shock, not credit-fuelled demand.

Donovan says Governor Waller at times sounded willing to accept a non-oil recession to engineer lower headline inflation. A half-point hike would make recession more likely than a quarter-point one, but he treats that as a risk case rather than the base case. Absent a restrictive policy that flirts with recession, a modest increase does little to nothing against current inflation, because the inflation comes from a supply shock rather than a surge in credit-fuelled demand.

“Absent a restrictive policy that flirts with recession, a modest rate increase will do little to nothing to curb the current state of inflation, because this is the result of a supply shock, not a wild surge in credit fuelled demand.”at 2:36

Paul Donovan · UBS Global Wealth Management

Tariff-driven price rises are fading only slowly; prices should plateau rather than fall unless new tariffs arrive.

The consumer price data showed some evidence of tariff effects fading, but less than hoped. Donovan says fading higher up the supply chain, which would show in Thursday's producer price data, would be more positive for the future. Prices will not fall if tariffs are lifted, but they should stop rising if no new tariffs are imposed.

“There was some evidence of fading tariffs in the consumer price data, but not as much as might have been hoped. ... Prices will not fall if tariffs are lifted, but they shouldn't increase further if no new tariffs are imposed.”at 3:09

Paul Donovan · UBS Global Wealth Management

Crude's moves reflect shifting risk perceptions, not supply and demand; optimism has largely run its course.

Optimism has already done about as much as it can to push crude prices down. Crude is fluctuating on changing perceptions of risk rather than on major shifts in current supply or demand, so the price moves are driven by sentiment rather than fundamentals.

“the optimism bias seems to have done as much as it can to bring down the price of crude for now. Crude prices are seemingly fluctuating simply on shifting perceptions of risk rather than on major changes to current supply and demand.”at 3:33

Paul Donovan · UBS Global Wealth Management

The House stalling Hegseth impeachment hearings may slightly temper expectations of an Iran deal.

The US House of Representatives failed to proceed with impeachment hearings against Defense Secretary Hegseth. Donovan argues this could, at the margin, moderate expectations of a deal with Iran. The link is indirect and the effect is only marginal.

“The failure of the US House of Representatives to proceed with impeachment hearings against US Defense Secretary Hegseth may, at the margin, moderate expectations of a deal with Iran.”at 3:53