Weekly Musings – Macro Quartet for the week ending August 30, 2024

2 Sep 2024 , 04:21 PM

REAL RATE CUT STORY LIES IN PCE INFLATION

It is well documented that the Fed considers the PCE inflation as the benchmark for deciding on the rate cut decision. One can argue that at 2.5%, the PCE inflation is moving towards the 2% mark. More so, since the average PCE inflation over the last 9 months has been just 2.58%. It should give a lot of comfort to the Fed as it navigates a key Fed meeting in September, where a rate cut of 25 bps is on the cards. The table below captures the PCE inflation on a yoy basis with granular break-up. Focus more on the granular break-up, which contains the real story of PCE inflation in India. Here are the key takeaways.

Break-up of PCE Inflation (YOY)	Dec-23	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24	Jul-24
Headline PCE Inflation (Year on Year)	2.6	2.5	2.5	2.7	2.7	2.6	2.5	2.5
Goods	0.2	-0.5	-0.2	0.1	0.1	-0.1	-0.2	0.0
Durable goods	-2.3	-2.4	-2.0	-1.9	-2.2	-3.2	-2.9	-2.5
Nondurable goods	1.6	0.5	0.8	1.3	1.4	1.6	1.2	1.3
Services	3.9	4.0	3.9	4.0	4.0	3.9	3.8	3.7
Addenda:
Core PCE excluding food and energy	2.9	2.9	2.8	2.8	2.8	2.6	2.6	2.6
Food	1.4	1.4	1.3	1.5	1.3	1.2	1.4	1.4
Energy goods and services	-1.7	-4.9	-2.3	2.6	3.0	4.8	2.0	1.9

Data Source: US Bureau of Economic Analysis (BEA)

PCE inflation can be looked at as a combination of durable goods inflation, non-durable goods inflation, and services inflation. At the same time, PCE inflation can also be looked as a combination food inflation, energy inflation, and core inflation. We will look at it both ways and here what we read from the break-up of the PCE inflation data for July 2024.

• Headline PCE inflation has shown a secular downward trend since April 2023. Between November 2023 and July 2024, the PCE inflation fell 10 bps to 2.5%. One can argue that last mile is just getting tougher; but that is the way it was supposed to happen anyways.
  
• In July 2024, the PCE inflation for goods overall, was at 0.0%, signifying no change yoy. However, this is better than -0.2% in June 2024 and -0.1% in May 2024. Within goods, the durable goods showed further improvement from -2.9% to -2.5% (albeit still contracting), while the inflation in non-durable goods bounced by 10 bps from 1.2% to 1.3%. You must take this data with a pinch of salt; since it comes on the back of a 40 bps spike in non-durable goods inflation seen in June 2024.
  
• For July 2024, the services inflation tapered by another 10 bps from 3.8% to 3.7%. However, in absolute terms, the services inflation continues to stay higher than anticipated and the fall in the last 3 months has just been 10 bps. Through most of last year, the services inflation was a key driver of overall headline PCE inflation. Over a 20-month period, the services inflation has fallen by a full 190 bps from a high of 5.6% in April 2023. However, if overall PCE inflation has to touch 2%, then services holds the key.
  
• Core PCE inflation yoy has shown a consistent downtrend from June 2023 till February 2024; falling 150 bps from 4.3% to 2.8%. Over last 3 months, core PCE inflation has been static at a level of just 2.6%. Food inflation was also flat at 1.4%, but again, PCE food is down 330 bps from 4.7% a year ago.
  
• Energy inflation is probably the swing factor, although the impact of the Red Sea crisis is gradually waning. Between January 2024 and May 2024, PCE energy inflation spiked 970 bps from -4.9% to +4.8%. In the last 2 months, energy inflation has eased by 290 bps, so this could drive PCE inflation towards the 2% target.

While energy inflation is likely to remain the swing fact, the focus of the Fed must be on curtailing the services inflation. Overall, goods inflation is under control and it is services that still remains well above the Fed’s 2% headline target.

US BOND YIELDS FLAT AND DOLLAR INDEX MARGINALLY HIGHER

Two macro variables that set the tone for the global macros are the US bond yields and the US dollar index (DXY). Let us first look at the US 10-year bond yields.

Date	Price (%)	Open (%)	High (%)	Low (%)
Aug 26, 2024	3.820	3.789	3.822	3.774
Aug 27, 2024	3.829	3.810	3.867	3.806
Aug 28, 2024	3.839	3.818	3.848	3.805
Aug 29, 2024	3.863	3.835	3.888	3.816
Aug 30, 2024	3.909	3.863	3.929	3.848

Data Source: Bloomberg

The US bond yields had tapered in the last two weeks after the inflation had shown steady downward progress. Also, the weak unemployment data had pulled down the yields on expectations of a larger rate cut in September. This week, bond yields were flat through the week, but bounced in the last 2 days after the US GDP data came in stronger than expected.

The late bounce in the bond yields this week was on the back of the 20 bps upgrade of the second estimate of Q2 GDP growth. The first advance estimate of Q2 GDP growth had already shown a sharp turnaround from 1.4% in Q1 to 2.8% in Q2. Now the second estimate has further raised the Q2 GDP growth target by 20 bps to 3.0%. For now, the question is not about whether the Fed will cut rates in September. That is almost looking like a done-deal. The bigger question that the markets are grappling with is what will be the interest rate trajectory after September. Will it continue to be influenced by the haws in the FOMC, or would the actual rate cuts also get aggressive as the CME Fedwatch is suggesting. The Fed may eventually settle for a middle path, although the nature of this middle path is unclear.

Date	Price (%)	Open (%)	High (%)	Low (%)
Aug 26, 2024	100.85	100.66	100.92	100.54
Aug 27, 2024	100.61	100.85	100.93	100.51
Aug 28, 2024	101.02	100.61	101.18	100.60
Aug 29, 2024	101.36	101.02	101.58	100.89
Aug 30, 2024	101.73	101.36	101.78	101.25

Data Source: Bloomberg

The growth triggers visible in the GDP numbers and the unwillingness of the Fed to commit on rate cuts has led the dollar to bounce back in the week. The dollar index bounced from 100.85 to 101.73. It still continues to remain well below the recent highs of nearly 107 levels. If the fears of a US slowdown (as shown by the August unemployment report), are belied, then we could see the dollar index gaining from here. For the week to August 30, 2024, the dollar index started at 1000.66 levels, but gradually inched higher through the week to close at 101.73 levels. The dollar index scaled a weekly high of 101.78 and low of 100.51 levels.

INDIA BOND YIELDS ALSO CLOSES FLAT AT 6.863%

In the recent week, the 10 year bond yields in India showed a late bounce, on hopes that the better than expected US GDP numbers should make up. Interest costs have been rising in India and interest coverage has been falling. It is expected that the RBI will take cognisance to prevent distorting the growth engine.

Date	Price (%)	Open (%)	High (%)	Low (%)
Aug 05, 2024	6.860	6.862	6.865	6.844
Aug 06, 2024	6.872	6.870	6.880	6.867
Aug 07, 2024	6.862	6.885	6.885	6.859
Aug 08, 2024	6.877	6.862	6.885	6.859
Aug 09, 2024	6.880	6.887	6.889	6.878
Aug 12, 2024	6.879	6.881	6.881	6.870
Aug 13, 2024	6.880	6.869	6.887	6.869
Aug 14, 2024	6.858	6.871	6.874	6.857
Aug 15, 2024	6.858	6.871	6.874	6.857
Aug 16, 2024	6.867	6.880	6.880	6.864
Aug 19, 2024	6.864	6.871	6.871	6.860
Aug 20, 2024	6.856	6.874	6.874	6.850
Aug 21, 2024	6.853	6.849	6.859	6.846
Aug 22, 2024	6.852	6.861	6.861	6.843
Aug 23, 2024	6.859	6.855	6.862	6.849
Aug 26, 2024	6.851	6.854	6.854	6.848
Aug 27, 2024	6.861	6.863	6.863	6.854
Aug 28, 2024	6.861	6.858	6.866	6.856
Aug 29, 2024	6.864	6.870	6.870	6.862
Aug 30, 2024	6.863	6.872	6.872	6.862

Data Source: RBI

During the week, the bond yield opened at 6.851% and closed lower at 6.863%. The trigger for higher bond yields came from the hint from the US Fed chair that only the first 25 bps rate cut would happen in September 2024. Anything beyond that looks hazy. During the week, India 10-year bond yields touched a high of 6.872% and a low of 6.848%. The immediate trigger for domestic bond yields will be the Kharif output and the outlook for food inflation, which should come in around middle of September. The real inflation signals will come from cereals, pulses, and vegetables.

RUPEE HOLDS ON, DESPITE DOLLAR STRENGTH

In the last 2 weeks, the RBI had been consistently intervening to defend the rupee from weakening beyond ₹84.$. This week, RBI support was not required.

Date	Price (₹/$)	Open (₹/$)	High (₹/$)	Low (₹/$)
Aug 05, 2024	84.018	83.793	84.182	83.757
Aug 06, 2024	83.930	83.996	84.000	83.833
Aug 07, 2024	83.885	83.955	83.994	83.878
Aug 08, 2024	83.990	83.942	84.011	83.924
Aug 09, 2024	83.951	83.989	83.994	83.885
Aug 12, 2024	83.930	83.915	83.985	83.899
Aug 13, 2024	83.910	83.949	83.983	83.911
Aug 14, 2024	83.960	83.920	83.985	83.896
Aug 15, 2024	83.940	83.963	84.007	83.936
Aug 16, 2024	83.880	83.945	83.979	83.887
Aug 19, 2024	83.850	83.865	83.952	83.826
Aug 20, 2024	83.780	83.877	83.927	83.406
Aug 21, 2024	83.892	83.780	83.970	83.628
Aug 22, 2024	83.941	83.892	84.007	83.889
Aug 23, 2024	83.814	83.941	83.942	83.800
Aug 26, 2024	83.840	83.806	83.923	83.787
Aug 27, 2024	83.910	83.870	83.965	83.870
Aug 28, 2024	83.900	83.963	83.988	83.910
Aug 29, 2024	83.880	83.944	83.956	83.839
Aug 30, 2024	83.872	83.893	83.956	83.813

Data Source: RBI

To an extent, the dollar strength concerns have been overcome. The dollar index may have bounced slightly in the week, but there are 3 factors favouring Indian rupee. Firstly, the oil prices fell sharply to $76/bbl in the Brent market. Secondly, weakness is built into the dollar with a likely 25 bps rate cut coming in September. Above all, FPI flows into Indian equities were robust at $2.82 Billion in the latest week. FPI infusion since the NDA government formation in early June has been to the order of $10 billion in equity alone. For the week, the USDINR touched a high of 83.787/$ and a low of 83.988/$. The INR appears to have taken support around the ₹84/$ levels.

BRENT CRUDE FALLS IN VOLATILE WEEK

The level of $80/bbl remains a resistance for crude, and this week Brent Crude eased after a promising start to the market. Brent Crude closed the week at $78.80/bbl.

Date	Price ($/bbl)	Open ($/bbl)	High ($/bbl)	Low ($/bbl)
Aug 05, 2024	76.30	77.61	77.74	75.05
Aug 06, 2024	76.48	77.45	77.85	75.58
Aug 07, 2024	78.33	76.16	78.87	75.95
Aug 08, 2024	79.16	78.55	79.37	77.63
Aug 09, 2024	79.66	79.03	79.83	78.77
Aug 12, 2024	82.30	79.56	82.40	79.46
Aug 13, 2024	80.69	81.88	82.30	80.55
Aug 14, 2024	79.76	81.00	81.44	79.60
Aug 15, 2024	81.04	79.96	81.43	79.61
Aug 16, 2024	79.68	80.86	81.02	78.62
Aug 19, 2024	77.66	79.60	79.81	77.48
Aug 20, 2024	77.20	77.66	78.35	76.55
Aug 21, 2024	76.05	77.13	78.21	75.65
Aug 22, 2024	77.22	75.96	77.70	75.77
Aug 23, 2024	79.10	77.24	79.27	77.03
Aug 26, 2024	81.43	79.35	81.58	79.24
Aug 27, 2024	79.55	81.26	81.59	79.47
Aug 28, 2024	78.65	79.87	80.01	77.95
Aug 29, 2024	79.94	78.52	80.78	78.12
Aug 30, 2024	78.80	79.92	80.60	78.57

Data Source: Bloomberg

Despite the growing tensions in West Asia, the oil prices continued to remain under pressure as doubts Chinese demand continued. Also, the US gasoline demand has been tapering, as is evident from the lower than expected drawdown in oil reserves. That is why, oil prices are not rallying, despite supply being restrained by the OPEC members. The dollar weakness could help oil prices rally a bit. Brent crude touched a high of $81.59/bbl and a low of $78.12/bbl.

SPOT GOLD HOLDS ABOVE $2,500/OZ ON ALL DAYS

The table below captures the international spot prices of gold in dollars per troy ounce (oz). A troy ounce is approximately 31.1035 grams.

Date	Price ($/oz)	Open ($/oz)	High ($/oz)	Low ($/oz)
Aug 05, 2024	2,407.65	2,443.27	2,458.80	2,364.40
Aug 06, 2024	2,389.37	2,410.01	2,418.35	2,381.79
Aug 07, 2024	2,381.53	2,389.67	2,407.05	2,379.05
Aug 08, 2024	2,426.75	2,382.43	2,427.80	2,380.70
Aug 09, 2024	2,431.14	2,424.55	2,437.10	2,416.98
Aug 12, 2024	2,472.25	2,431.21	2,473.48	2,423.84
Aug 13, 2024	2,465.03	2,472.64	2,477.02	2,458.50
Aug 14, 2024	2,447.64	2,467.40	2,478.49	2,438.12
Aug 15, 2024	2,456.10	2,448.15	2,470.25	2,432.19
Aug 16, 2024	2,507.28	2,456.57	2,509.89	2,450.76
Aug 19, 2024	2,503.92	2,508.40	2,510.45	2,485.83
Aug 20, 2024	2,513.74	2,501.55	2,532.05	2,497.33
Aug 21, 2024	2,511.95	2,512.82	2,520.09	2,494.15
Aug 22, 2024	2,487.66	2,512.94	2,514.69	2,470.91
Aug 23, 2024	2,512.41	2,487.60	2,518.36	2,486.56
Aug 26, 2024	2,516.89	2,511.43	2,527.76	2,508.71
Aug 27, 2024	2,524.57	2,518.30	2,526.27	2,503.41
Aug 28, 2024	2,502.25	2,522.74	2,529.15	2,493.66
Aug 29, 2024	2,521.18	2,504.65	2,528.77	2,503.65
Aug 30, 2024	2,503.45	2,519.62	2,526.80	2,494.34

Data Source: Bloomberg

Spot Gold opened the week strong at $2,516.89/oz but eventually closed the week at $2,503.45/oz amidst volatility. This week, gold stayed above $2.500/oz. The near confirmation of a rate cut in September is making gold more attractive as it reduces the opportunity cost of holding gold. Dollar weakness and central bank buying are boosting gold. Meanwhile, the geopolitical strife is triggering safe-haven demand for gold. During the week, gold touched a high of $2,529.15/oz and a low of $2,493.66/oz.