Top of the Morning: CIO Strategy Snapshot - US-Iran conflict: Assessing the market & macro impacts

Hi, everyone, Dan Cassidy here. Welcome back to top of the morning on the UBS Market

Moves podcast channel. We are now in the third week of the U.S. Iran conflict and investors

remained focused on how long it could last and the potential economic consequences. Now,

there are other developments relevant for the investment outlook, including economic

data and how the Fed incorporates the oil price shock into its decision making at the

FOMC meeting this week. So joining us here on this Monday morning to discuss this all

for the CIO strategy snapshot. Glad to welcome back head of asset allocation for the Americas

from the UBS chief investment office, Jason Dreho. Jason a lot has, of course, taken place

since you and I last spoke. So it's a great to have you back on the podcast today. Thank you

for joining our listeners and our clients on this Monday morning. I wanted to have been

Monday. It's been a couple of weeks since we talked and I'm sure a lot has happened during that

time period. So with that, Jason, perhaps geopolitics, a good place to start. Can you bring our listeners

up to speed as far as CIO's latest thinking on the U.S. Iran conflict? When it might be resolved

and the outlook for oil? Well, we can do a lot of speculation in terms of how this could be resolved,

when it could be resolved. I think from the market perspective, really what matters more is,

you know, in terms of, it's in terms of the duration of the conflict, you know, and how this will

impact oil prices, any of the passage of oil and other goods through the street of Hormuz,

and how long that could be disrupted in one way or another. YARC based case remains that the

hostilities between the U.S. and Iran will not lead to a sustained rise in energy prices,

even if the events remain uncertainly in at least the next couple of weeks if not a little bit

longer. If you look at what happened just over the past, you know, in a few days of the weekend,

on Friday, the U.S. bomb military targets on Iran's main oil export hub on Card Island.

And President Trump threatened additional strikes. Can you target any of your facilities if

you know, Tehran doesn't or can use the block the street of Hormuz in warned around that there

could be more consequences of attack on that energy infrastructure. But Trump has also said in

containment that the U.S. has achieved its military objective is now seeking to international

support to reopen this trade and to reconvert from that as an indication that the U.S. is ultimately

looking for an off-round. And, or quite a turn out look on the Wall Street Journal, the

Trump administration does plan to announce this week that it's formed a coalition with a number of

companies to help its courtships through the street. So, you know, while obviously the uncertainty

remains high, there's clearly, you know, the administration looks like they want to, you know,

still have this resolve within four to six weeks, which was the initial sort of time frame

let out by the president in two weeks ago. And just as a positive note to kind of reinforce this

view, you know, two tankers carrying liquefieds, petroleum gas, the Indian did go through the street

over the weekend. So, there is some signs of at least you know, it's not complete shutdown.

And ultimately though, in terms of going back to the price of oil, you know, the situation is

very much in flux and the combination of the supply disruptions, for the limited offset from

increasing the releases from the strategic reserves, you know, all parts of the length is

they hire for longer, even if the flows through the street of hormones resume, you know, in within a

few weeks. As a result, our commodities team has upgraded their price targets for brand crude,

and now expecting it to be $90 a barrel at the end of June, this is up from 65, and then it falls

to 85 by September, 85 in December, then down to 80 by next March. So, it will take a while for this

to denormalize either the prices for Brent at WT9 in the US. You know, it's always going to be a little

bit lower, but like the sum about $4 or $5 lower per barrel. So, a little bit higher of almost,

you know, $15 to $20 kind of across the time horizon that we're talking about. So, even if this

disruption gets resolved, you know, about the assuming within the next month, just the fact that

the strategic reserves will be drained in, you know, last week, OECD countries agree to at least

afford agreement barrels from their strategic reserves. As they release those, it takes not only

to adapt it and sort of rebuild it, but that also kind of augments the demand overall for oil,

and all that leads to higher oil prices going forward. These forecasts assume that the straight

will resume by end of March, early in May, or early in April, the disruption is a lot slower than

you know, ultimately you can see Brent going all the way to $150 a barrel. To ultimately, you would

need some demand destruction to curtail demand to bring enterprises lower. So, there is certainly

risks of going higher in near term, the idea that we get back to price levels that exist

just a month ago, that's unlikely to happen anytime soon. So, the situation may resolve,

you know, in terms of this oil impact and oil disruption to the supply in a relatively soon,

but the impact for oil or prices is likely to linger through much of this year into early next

year as well. Now, one of the key questions, Jason, is how the surge in oil prices could impact

the economy? What is the risk and what does the current data say about the state of the economy?

Well, if we think about just the potential risk to the economy from high oil prices,

it's a general rule of thumb that sustained increase in the price of oil by $10 per barrel,

well, you know, would drag down GDP growth by about 10 basis points all is equal. And so,

if you think of oil state at, you know, roughly the 85 of an annual range versus 65, you know,

prior to that, let's say that's, you know, $20 a barrel higher that sustained throughout the

rest of this year, if that could drag down growth ultimately, you know, 10 to 20 basis points.

That's historical relationships. The over time, the U.S. has become a more energy independent,

it's the largest oil producer in the world. It's a sometimes high oil prices. Well,

if it's consumers can benefit producers, it's unlikely if prices use that to moderate,

that you're going to see much of a ramp up in production, but the U.S. versus some other

economies is certainly an Asia to Europe at some extent because of this sort of relative energy

independence, a little bit more immune to higher oil prices overall, but it's still a negative,

it's still inflationary, it's still sort of a stagnationary shock, which can reflect the market

performance of light. If we hold constants, you know, the oil dynamics and what's happening there,

and the potential impact going forward, we actually look at the recent data, it is still consistent

with the base case that we had that growth would be around two and a half percent this year,

you're taking, you know, the 10th or two measured by kind of a fourth quarter this year versus

fourth quarter last year. Last week, there was GDP data for the fourth quarter of the

overversion to it, and it was revised lower by 70 basis points, you know, down to 0.7 from 1.4%,

and this was revised lower due to kind of exports being revised lower and consumers spending

also following. But just to put in context, consumer spending, if you look at the consumer

overall, it went from 2.4 to 2% and real domestic final sales growth, which kind of strips up

the noise from exports, from the majorories, was still 1.9%. So still, relatively solid

private sector demand, although that is a step down from where growth was in the second and third

quarter of last year, then we look at more real-time data, you know, the jobs report that we got

for February, you know, was weak, you came in at minus 92,000, terms of job growth,

one of the contences is about expectation plus 25,000. But if you take a step back,

I look at the labor market picture overall, some of the weakness in February could reflect some

of the piggyback from January being overstated. There's a lot of seasonal issues with the January

jobs data, and if we look at sort of three and four months in a moving average, it looks like

not necessarily a trend shift lower, you know, but just to continue with sort of the

soft labor market and other indicator, if it's just, you know, jobless claims or announced

job openings, you don't well show, well, you know, uptick in job losses, which suggests that

the unemployment rate is likely to still stabilize around the current level, like say, 4.3 to 4.5,

you know, percent. One of the reasons why we're optimistic on growth this year instead of

acceleration is that the benefits of the stimulus package from last year, the one big,

beautiful bill should be kicking in. Some that we're tracking closely is the tax refunds.

They're expected to be larger this year, you know, given that the tax cuts were retroactive.

You know, as of about a week ago, they were up about 13 billion year, an average refunds looked

to be about 11 percent. The data, though, is tracking the lower end of the estimates of

between 50 to 100 billion dollars in terms of sort of tax refunds incremental to above me on what

has normally done. So what it looks like, though, is it's likely to be maybe later in the season,

some more of a two-q story in terms of growth impact rather than the first quarter story,

as opposed to the overall sort of stimulus benefit being kind of lower than initially anticipated.

Wouldn't we get that sort of benefit of the tax cuts, but also lower, you know,

tax payments kind of going forward? We expect a job growth will rebound to some extent in support

by a firm or kind of growth outlook. So putting a big picture, if we abstract what's going on from,

you know, the high oil prices due to the conflict in the Middle East,

you know, the macro stories plan out largely as going to be expected, you know,

the labor market is, you know, yet to kind of improve, but it's not necessarily getting any

worse despite the February data and the stimulus benefits, including the accelerate investment

should lead to pick up and growth in the second quarter. That should support the job growth going

forward. Now, as far as how the Fed may be assessing this all, the Fed, of course, does meet this

week to decide on changes to interest rates, this in light of the higher oil prices. Jason,

what are you expecting from the meeting this week? And how could oil impact the Fed's rate-cutting

decisions? Well, high oil prices certainly doesn't, you know, make the Fed's life any easier,

because it is going to be inflationary shock. It's one of the reasons why if you look at market

pricing, it's now down to only one cut this year and that has been occur until December.

I think it's back where we were in early January. It was close to two and a half of three cuts

in a first-fold cut here by by June, and now that's definitely been pushed out.

Ultimately, we still expect the Fed's going to cut to you twice this year, June, September,

you know, the risk is that this could be delayed a little bit. But the rationale for this

ultimate is the inflation impact, especially to core inflation from, you know, higher oil prices

is relatively modest, and using that sort of theme and a rule of thumb for growth,

a $10 increase in the barrel of oil for sustained period of time,

should translate into about four basis points higher of core inflation. And for headline,

if it would be hard, it could be close to 20 basis points, but the Fed is going to

kind of look through that and focus on core inflation. The underlying transfer of inflation,

by and large, still seem to be moving the right direction, shelter inflation is going lower.

Some of the good inflation, you know, shows, you know, an uptick in February. That is going to

be consistent with the tariff stores still having an impact. And we think that's kind of,

you know, kind of still to play out and work its way through the system, you know, by the end of

the second quarter. But nonetheless, higher inflation doesn't make it easier for the Fed to cut.

But like the market pricing seems to be a little bit overreacting. Ultimately,

the Fed is a dual mandate, both higher inflation and job growth. And so while there's a risk of

higher inflation, at least to headline numbers for a extended period of time, because the oil prices

the February job data, as much as we can try to suggest it, you know, still, you know,

implying it's stabilized in labor market. That's highlighted the fact that there is significant

downside risk to the labor market. And so from the Fed's perspective, and something that Jay

Palo might say during his press conference at the end of the FOMC meeting, is that the risk for

in balance, inflation risks have increased, but also labor market risks have also increased

to the downside. So you get it all out, the Fed's all looking to remain as kind of relatively

balanced. So as a result, in terms of what to expect for the Fed this meeting, you know, rate cuts,

they may, although likely can update their economic projections to show slightly higher inflation

is slightly lower growth for 2026, slightly higher unemployment rate, you know, what you would get

from it is a negative supply side shock. The median dot at the December meeting implied one cut

this year. I'll be expecting that to be the same, you know, this time as well. They don't require

pretty big change among different committee members to shift that median from one cut to either

no cuts or or very likely goes to two cuts at this point in time. So largely kind of status

co-meeting in the Fed is going to operate in a bit of a fog. Palo will probably read her at that point.

In just regard in some of the market pricing, it's priced out a lot of cuts this year, or at least

in push things further back. This has also occurred last week and largely the week in which it's

part of this led back up period going into the FOMC. So there was no effect if there's always

able to kind of talk back and push back against the market pricing. And so Palo's comments could

sort of challenge some of that view and you could see the market answer. We priced back some of

these cuts just sort of pulled them forward after the FOMC and after the Fed's indicated willingness

to perhaps look through the Fed meetings. In terms of the cuts, you know, we're maintaining our

view of June and September, there's basically two paths for the Fed to get there. One,

ultimately, is that it's in a place in store, right in a place in, you know, trends look like

they're moving in the right direction. So that core goods in a place in over the next three to

six months, you know, look like they have peaked. And by the time they get to the June meeting,

they'll have media data and from March to May, that could look a lot better. So if they don't,

you know, you know, put too much emphasis on oil, then core inflation could fall enough for them

to justify cutting in June. Another factor for them to be able to cut in June is if we get another

one of two months of weak jobs numbers, you know, high unemployment rate, you know, that could

override inflation data. So there's different paths for the Fed to be still cutting in June and

think the market has become a little bit perhaps too much physical in that prospect.

So let's end Jason on investment recommendations. What are the key messages at this time from the

UBS Chief Investments Office and how should investors navigate market turbulence?

Well, let me start with just reiterating the macro view that we had for this year of, you know,

solid growth, kind of with growth accelerate in the first half of the Fed that is still biased

towards cutting, you know, twice this year. You know, so far we don't think that view as

is materially changed or the what's developments of the past week haven't materially changed

that I'll like. And those are supportive conditions for risk assets and equities in particular

to do well. So I think for that reason, you know, if we take a medium-term view, like a full year view,

we still remain kind of optimistic on that. But we have to acknowledge that in the near term,

uncertainty remains high and the markets could react to any of the new slow and will react

in the new slow regarding potential, either open to the straight-up promotion or for the

disruptions that could take kind of longer. And there's certainly a down-to-earth risk if the

perceptions are this will not reopen in the next, let's say, within the next month. It does look like

investor sentiment in position, yes, we've gotten kind of a new close to neutral. And by

large, I think there's a lot of investors who during the first week of this conflict,

were sort of relative to the same one. I thought that through, you know, in the president,

would ultimately kind of step back on in terms of his deactions, you know, if the market and the

economic and like you just became too negative. After the second week of the sentiment on that,

got a little more pessimistic, not that, you know, the administration is not aware of the economic

considerations, but unlike say, with tariffs, where they can unilaterally take action,

this situation with Iran is not unilateral. They have to kind of also respond to what Iran does.

And so I think there's a little bit more pessimism that is creeped into the markets as a result.

And you're seeing something on the market performance reflect that. And that could be

being the investors in the market's overall can be very sensitive to any new slow, the next few

few weeks on this regard. As a result, you know, we continue to simply believe that the best way

to navigate this environment is to make sure that you're sort of diverse upon it across

urban ask glasses, sectors and regions, something that we've been evaluating, we're back, you know,

prior to these developments, you know, looking at other sort of, you know, hedges, you know,

such as capital preservation strategies, you know, continue to like gold and commodities to sort

of, you know, diversifiers as a way to sort of navigate to this environment. I think the key

thing is the overall medium per message, you know, remains kind of constructive. And investors

shouldn't be looking to kind of panic and fearful that, you know, there's a lot more downside.

That is true. I know there is a risk, but, you know, a mild gross care would suggest the

markets would have maybe a little more fall from here. But ultimately, we think the fundamentals

still suggest you better grow the head. And that's a better environment for, for equities.

The last point I'd make on equities is that a key driver for US equities in particular is

the AI CapEx investment that could drive a big part of the S&P earnings. That's going to be

less sensitive to what's happening in the Middle East. So the upside there for earnings still looks

attractive. And based off the completion of the Q&A season, we still focus in quite confident

that earnings element is she will sort of materialize, you've borne a much more tail risk scenario

with oil prices spiking all the way down to $150 a barrel. Well, Jason, a very helpful conversation

as we begin another trading week. Thank you for dropping by to share with our listeners,

our clients, your assessment of the current geopolitical environment, the economic environment,

how it's all translating to the markets, perhaps influencing monetary policy, and how to

position portfolios accordingly. So thanks again for dropping by Jason and have a great week ahead.

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