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.
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.
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
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.
