Oil Prices Poised to Drop to $80-$85 Post-Conflict, While Federal Reserve Faces Scrutiny, Says UBS Economist

The week has seen significant market shifts. Oil prices experienced a sharp decline of over 7 percent on Monday, following indications from the presidents of the US and Iran that they are open to a diplomatic resolution. Adding to the week's drama, the US midterm elections on Tuesday resulted in the Democratic Party securing control of both the House of Representatives and the Senate. In an interview conducted in Abu Dhabi prior to the election results, Paul Donovan, chief economist at UBS Global Wealth Management, shared his outlook. He anticipates that oil prices will continue to fall once the current conflict concludes. "I think we’re looking at, as it were, a fundamental fair value for the oil price is probably around $80, $85 a barrel, something like that," Donovan stated. "That’s where we probably settle … in a postwar environment." He explained that while the recent geopolitical tensions have eased some risk from the market, the core principles of supply and demand remain unchanged.

Federal Reserve Risks Under Scrutiny

Donovan highlighted that the Federal Reserve presents a more significant risk. Even before any votes were cast, he emphasized the Senate's crucial role in monetary policy, as Fed governors require its confirmation. He noted that with "a great deal of … Democrat anger at the administration," a Democratic-controlled Senate could potentially block President Donald Trump's nominees or delay the confirmation process. "For the most part, I don’t care about … ambassadorships or frankly even cabinet posts most of the time, but the Federal Reserve … that matters," he asserted.

Should any Fed governors depart and their positions remain vacant, the influence of the five regional Fed presidents, who "tend to be somewhat more hawkish than the governors," would increase. Despite this, Donovan foresees minimal further interest rate hikes, suggesting, "So I think rate hikes in ’27, if we get any, we maybe get one." He believes that inflation is not proving to be persistent, but rather it only appears so due to a series of distinct, one-off inflation shocks that central banks have limited control over. These shocks include supply chain disruptions following the pandemic, Russia's invasion of Ukraine, recent tariffs, and the current regional conflict.

Donovan pointed out that the impact of tariffs is already diminishing in US economic data, and oil prices could follow suit. He observed, "We’re seeing no wage price spirals, nothing like anywhere in the developed world, certainly not in the United States where real wages have been falling." If oil prices remain stable or slightly decrease compared to the previous year by the second quarter of next year, "you very rapidly get back to a more normal inflation picture." This stabilization, however, is contingent on oil prices falling and the resilience of the American consumer.

He described the American consumer as having been stoic rather than extravagant, choosing to reduce savings rather than cut back on other spending to accommodate higher oil prices. While this savings cushion is now thinner, consumers are less prepared for another shock. "but as long as you don’t get future shocks, then they carry on … in a stable way," Donovan added.

The 'Productivity Pixie' Debate

Donovan expressed a less favorable view of the new Fed chairman, Kevin Warsh, stating, "I think it is unfortunate that he has chosen to … not communicate clearly." He characterized the known aspect of Warsh's economic philosophy as a belief that "he believes the productivity pixie is gonna magically solve all problems in the future." This "pixie" represents the hope that a surge in productivity will resolve future economic challenges. When asked if he shared this optimism, Donovan replied, "I do not believe in the productivity pixie, I’m afraid. I think it is a convenient excuse to make everything in the future add up when actually everything in the future doesn’t really add up at the moment."