Oil could fall to $80-$85 after war, while Kevin Warsh believes in pixies, UBS economist says

It has been a dramatic start to the week. Oil fell by more than 7 per cent on Monday after the presidents of the US and Iran signalled they were open to a diplomatic solution, and on Tuesday the Democrats won control of both the House of Representatives and the Senate in the US midterm elections.

We sat down with Paul Donovan, chief economist at UBS Global Wealth Management, in Abu Dhabi on the eve of the election, before the Democratic wave.

He says oil has further to fall once the fighting is over.

“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,” he said. “That’s where we probably settle … in a postwar environment.”

The fall took some geopolitical risk out of the market, he said, “but what we haven’t changed is the fundamentals of supply and demand”.

Federal Reserve risks

The bigger risk sits with the Federal Reserve.

Before a single vote was cast, Mr Donovan said the Senate mattered most for monetary policy, because Fed governors need its confirmation. With “a great deal of … Democrat anger at the administration”, a Democratic Senate could refuse US President Donald Trump’s nominees or drag the process out.

“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 said.

01:18

How low can oil go? UBS Wealth Management's chief economist on postwar prices

If governors leave and their seats stay empty, the five voting regional Fed presidents gain weight, and “the regional Fed presidents tend to be somewhat more hawkish than the governors”, he said.

Even so, he expects little tightening.

“So I think rate hikes in ’27, if we get any, we maybe get one,” he said. “The inflation actually isn’t persistent.”

It only feels that way.

“The problem is we’ve had a whole succession of one-off distinct inflation shocks, which the central banks can do very little about,” he said.

He counted them off: supply chain disruption after the pandemic, Russia’s invasion of Ukraine, the tariffs and now the war in this region.

“It’s a series of very distinct, discrete temporary effects.”

The tariff effect is already fading from the US figures, and oil could follow.

“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,” he said.

If oil prices are flat or slightly down on a year earlier by the second quarter of next year, “you very rapidly get back to a more normal inflation picture”.

It all hangs on oil.

“So it is contingent on the oil price coming down,” he said.

It also hangs on the American consumer, who in Mr Donovan’s telling has been stoic rather than hedonistic.

“Consumers did not cut back on other spending in order to pay for the higher oil price. They cut back on savings,” he said.

That cushion is thinner now, and shoppers are less ready for another shock, “but as long as you don’t get future shocks, then they carry on … in a stable way”.

The productivity pixie

Mr Donovan was less kind about the new Fed chairman, Kevin Warsh.

“I think it is unfortunate that he has chosen to … not communicate clearly,” he said.

The only thing known about Mr Warsh’s thinking, he said, is that “he believes the productivity pixie is gonna magically solve all problems in the future”.

The pixie is the hope that a burst of productivity will make tomorrow’s sums work.

Asked whether he shared that faith, Mr Donovan said he did not.

“I do not believe in the productivity pixie, I’m afraid,” he said. “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.”