Jan 29 / Alef Dias

Macroeconomics Weekly Report - 2024 01 29

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War and GDP - more risks for FOMC's week

  • In view of last week's events and the imminence of another FOMC (Federal Open Market Committee) meeting, we need to turn our attention to the Fed once again.
  • Last Sunday, a drone strike killed three American soldiers. These were the first American deaths since Israel and Hamas went to war and could have a significant impact on the macroeconomic scenario.
  • US real GDP growth was 3.3% in Q4, above consensus estimates of 2.0%. This stronger economic growth could delay the convergence of inflation towards the Fed's 2% target.
  • However, the latest PCE data showed a more benign scenario for one of the main price indexes monitored by the Fed, which favors an early interest rate cut.


Given the events of the last week, and the imminence of yet another FOMC meeting, we have to return to the main macro theme of the first half of 2024: the start of monetary easing in the US.

Escalation of the war raises the risk of an inflationary rebound

Last Sunday, a drone strike killed three American soldiers and wounded 34 others. The attack took place at a base near the border between Jordan and Syria. The US blamed Iranian-backed militants for the attack, while Tehran denied any connection to the strike.

The event is important. It resulted in the first American deaths since Israel and Hamas went to war on October 7. President Joe Biden has promised retaliation. The event could lead the US and Iran to war, despite their mutual aversion to direct confrontation. Oil prices rose to $84 a barrel after the attack.

There are two scenarios for how things will unfold next:

- The first, and most likely, would be a "one-off" counter-attack. The US hits Iranian targets or officials, and Iran doesn't escalate. The scenario is similar to what happened in 2020, when the US assassinated Iranian general Qassem Soleimani, and Iran did not respond in the same way. The assassination took place after the invasion of the US embassy in Baghdad.

- Secondly, an escalation of "an eye for an eye". The US hits Iranian targets or individuals, and Iran responds by hitting US interests, either directly or through its network of proxies and allies in the region.

The second scenario would potentially escalate the conflict to a wider level, adding a significant risk to global inflation, since much of the world's maritime trade passes through the Strait of Hormuz. A fifth of the global supply of crude oil would be at risk. Oil prices could rise to triple digits and a global recession could occur.

However, neither the US nor Iran want an escalation, which makes the first scenario more likely. Before the latest attack, Washington was considering reducing arms sales to Israel to prush for a reduction in operations in Gaza. The country is also involved in negotiations over a possible ceasefire in exchange for the release of hostages.

Image 1: Crude Oil WTI (USD/Bbl)

Source: Refinitiv

Strong GDP increases risks

US real GDP growth cooled to a strong 3.3% in Q4 (vs. 4.9% previously). This was above consensus estimates of 2.0%. Consumer spending accounted for most of the growth, expanding at a pace of 2.8% (vs. 3.1% previously).

The trade balance also contributed to the "surprising" GDP. Exports expanded at an accelerated pace of 6.3% (compared to 5.4% previously), mainly in services. Imports grew by just 1.9% (compared to 4.2% previously), also driven mainly by services.

Overall, the economy recorded rapid growth of 3.1% for the whole of 2023, up from 0.7% the previous year. This result brings more confidence regarding the resilience of American economic activity, but there are still risks that must be monitored.

Growth in Q4 was largely driven by volatile categories and government spending. Business investment in equipment remained mostly sluggish, and inventories are likely to hamper future growth

Image 2: Real GDP (YoY) - US

Source: Bloomberg

Despite risks, new inflation data favors interest rate cut in March

PCE inflation (Personal Consumption Expenditure price index), one of the main indices monitored by the Fed, rose by 0.2% month-on-month (vs. -0.1% previously) - in line with expectations, and keeping annual PCE inflation at 2.6%. The pace of core PCE increased to 0.2% month-on-month in December, up from 0.1% previously, but base effects allowed core annual inflation to fall to 2.9%, down from 3.2% previously.

Even as personal income and spending posted robust gains in December, inflation's momentum is slowing. The three-month annualized pace of core PCE inflation fell to 1.5%, and the six-month pace remained at 1.9% - both below the Fed's 2% average inflation target.

Image 3: Core PCE (YoY) - US

Source: Refinitiv

In Summary

It could be said that the events of the last week have increased uncertainty as to when the Fed will begin its monetary easing cycle. The escalation of tensions between the US and Iran could have major impacts on energy and freight prices, while the resilient economic growth seen in the latest US GDP data could delay the convergence of inflation towards the Fed's 2% target.

However, the latest PCE data showed a more benign scenario for one of the main price indices monitored by the Fed, which favors an early interest rate cut. At the time of writing, the market was pricing in a 49.6% chance of an interest rate cut at the March meeting. As a result, this week's meeting is extremely important to understand what the FOMC's vision is for the next few meetings and what "conditions" are necessary for the interest rate cut cycle to begin.

We continue to believe that inflationary risks and the resilience of American economic activity and the labor market could "prevent" a rate cut in March, which could put downward pressure on commodities in the short term. However, the chances of the Fed cutting interest rates by May are 90.5%, so if there is no major escalation of tensions in the Middle East, we should see a reversal of this downward trend in the second quarter.

Image 4: Fed Funds Rate probabilities - meeting 20/03/24

Source: CME

Weekly Report — Macro

Written by Alef Dias
Reviewed by Victor Arduin


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