Weekly Musings – Macro Quartet for the week ending December 22, 2023

24 Dec 2023 , 10:04 AM

OIL FACES RED SEA PREMIUM, GOLD BOUNCES

It was a week when the price of Brent Crude oil bounced back to $80/bbl levels. In the last few weeks, the big story that had been pushing oil prices lower is the increasingly important role played by the non-OPEC countries in oil supply. Also, the fissures within the OPEC were widening with Angola declaring its decision to exit the OPEC. But despite these factors, the price of crude oil spiked this week due to the problems in the Red Sea. The Red Sea between Asia and Africa is one of the most important trade routes and Houthi rebels in Yemen have been making life difficult on this route. The spike in oil prices is reflective of higher risk premium and higher insurance costs getting built into the prices.

Gold continued to rally in the week closing above the $2,050/oz mark. There were three factors that helped gold prices spike. Firstly, the Red Sea crisis has once again brought back the safe haven demand for gold, which is normal practice in any geopolitical crisis. Secondly, the sharp fall in the dollar index from 107 levels to 101 levels is automatically accretive for gold prices; since gold is denominated in US dollars. Finally, the dovish signal given by the Fed in its last statement, has also boosted the fortunes of gold, since lower interest rates automatically means that the opportunity cost of holding gold comes down sharply.

GLOBAL DOVISHNESS; BUT INDIA DATA INDIFFERENT

During the week, the sharp fall in the US bond yields and the US dollar index were expected to weaken the India bond yields and harden the rupee. Nothing of that kind happened. During the week, the Indian bond yields actually bounced and the Indian rupee weakened. What explains this rather anomalous behaviour of Indian macros? Firstly, the Indian bond yields are still ambivalent as the liquidity conditions remain tight and that is pushing up the short term yields. Also, inflation continues to remain a pressure point, so bond yields are still biding their time. On the Indian rupee, the weakness comes from the expectation that the current account deficit may end up being higher than 2% of GDP for FY24. Also, amidst the euphoria of FPI flows, there are concerns that the situation could change drastically for the worse, should the Yen carry trades start to unwind rapidly.

US BOND YIELDS FALL FURTHER; DOLLAR INDEX LOWER?

Two macro variables that set the trend 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 (%)
Dec 18, 2023	3.935	3.931	3.971	3.890
Dec 19, 2023	3.931	3.930	3.952	3.894
Dec 20, 2023	3.853	3.924	3.924	3.847
Dec 21, 2023	3.892	3.864	3.905	3.829
Dec 22, 2023	3.901	3.888	3.921	3.849

Data Source: Bloomberg

US bond yields, are now a full 110 bps below recent peaks of 5%. This underlines the Fed view that the spike in bond yields had less to do with Fed hawkishness and more to do with yield curve alignment; as longer term yields adjusted upwards. During the week, US bond yields fell sharply from 3.935% to 3.901%; largely triggered by the US Fed bidding farewell to hawkishness. Apart from the rate cut guidance, the latest PCE inflation coming in at 2.6% has also been instrumental in pushing the US bond yields lower.

Date	Price (%)	Open (%)	High (%)	Low (%)
Dec 18, 2023	102.56	102.59	102.63	102.38
Dec 19, 2023	102.17	102.47	102.63	102.07
Dec 20, 2023	102.41	102.19	102.54	102.16
Dec 21, 2023	101.84	102.39	102.45	101.74
Dec 22, 2023	101.70	101.76	101.89	101.43

Data Source: Bloomberg

The sharp fall in the dollar index (DXY) continued in the current week. The dollar index (DXY) is an index of dollar strength against a basket of hard currencies like the Pound, Euro, Yen, Chinese Yuan etc. While the rupee may not be part of this basket of hard currencies, the dollar index still has a strong bearing on the rupee value. Just a couple of months back, the dollar index had touched a level of 107, something that has only been witnessed thrice in the last 40 years. The recent Fed policy displayed a distinct shift towards dovishness and that has sharply weakened the US dollar. 

The dollar weakness was quite sharp, with the DXY falling from 102.56 levels to 101.70 levels by close of the week. The weakening dollar index is already a signal that the rate cuts may be done and dusted and the Fed would now focus on the downside. If the rates were to actually be cut by 175 bps or more in the next two years, it would mean a strong possibility that the dollar index will weaken further. While hawkishness of the Fed helps the dollar to strengthen, the reverse is true in dovishness.

INDIA BOND YIELDS BOUNCE BACK DURING THE WEEK

Indian bond yields for the week to December 22, 2023 bounced from 7.153% levels to 7.188%. It is surprising to see the bond yields rising at a time when global central banks are dovish and US bond yield have tapered. The table captures bond yields over last 4 weeks.

Date	Price (%)	Open (%)	High (%)	Low (%)
Nov 27, 2023	7.272	7.278	7.291	7.266
Nov 28, 2023	7.273	7.258	7.277	7.253
Nov 29, 2023	7.252	7.258	7.258	7.237
Nov 30, 2023	7.279	7.250	7.287	7.248
Dec 01, 2023	7.290	7.293	7.298	7.279
Dec 04, 2023	7.271	7.264	7.276	7.262
Dec 05, 2023	7.262	7.275	7.275	7.256
Dec 06, 2023	7.248	7.251	7.254	7.243
Dec 07, 2023	7.236	7.248	7.248	7.233
Dec 08, 2023	7.266	7.249	7.271	7.226
Dec 11, 2023	7.281	7.287	7.287	7.273
Dec 12, 2023	7.275	7.279	7.280	7.267
Dec 13, 2023	7.259	7.262	7.269	7.257
Dec 14, 2023	7.194	7.222	7.224	7.185
Dec 15, 2023	7.163	7.204	7.206	7.155
Dec 18, 2023	7.153	7.171	7.179	7.147
Dec 19, 2023	7.171	7.185	7.185	7.153
Dec 20, 2023	7.171	7.184	7.184	7.165
Dec 21, 2023	7.184	7.173	7.188	7.151
Dec 22, 2023	7.188	7.187	7.198	7.185

Data Source: RBI

During the week, the bond yield opened at 7.153% but bounced sharply in the last three days to close the week at 7.188%. India inflation for November came in higher and there were fears that if the JN.1 variant became more serious, then the government may against have to throw helicopter money to boost the economy. That is not looking like any real risk at this point of time, but markets are still quote wary. Also, the bond markets are betting that the RBI may not exactly follow the US Fed when it comes to aggressive rate cuts.

RUPEE WEAKENS MARGINALLY DURING THE WEEK

For the twelfth week in a row, the Indian rupee stayed above the 83/$ mark. This week, the rupee opened at 83.144/$ and closed weaker at 83.166/$ levels. This is despite the fact that the US dollar index also showed signs of weakening during the week.

Date	Price (₹/$)	Open (₹/$)	High (₹/$)	Low (₹/$)
Nov 27, 2023	83.330	83.324	83.433	83.309
Nov 28, 2023	83.340	83.358	83.399	83.292
Nov 29, 2023	83.352	83.292	83.383	83.260
Nov 30, 2023	83.357	83.359	83.419	83.290
Dec 01, 2023	83.260	83.356	83.375	83.240
Dec 04, 2023	83.426	83.217	83.461	83.215
Dec 05, 2023	83.320	83.431	83.439	83.317
Dec 06, 2023	83.332	83.325	83.381	83.286
Dec 07, 2023	83.343	83.337	83.398	83.311
Dec 08, 2023	83.440	83.355	83.584	83.237
Dec 11, 2023	83.350	83.409	83.451	83.349
Dec 12, 2023	83.396	83.368	83.434	83.324
Dec 13, 2023	83.350	83.399	83.438	83.346
Dec 14, 2023	83.307	83.287	83.372	83.266
Dec 15, 2023	83.020	83.308	83.332	82.927
Dec 18, 2023	83.144	83.018	83.173	82.910
Dec 19, 2023	83.106	83.153	83.228	83.070
Dec 20, 2023	83.139	83.111	83.237	83.087
Dec 21, 2023	83.214	83.166	83.291	83.156
Dec 22, 2023	83.166	83.221	83.275	83.102

Data Source: RBI

After closing at 83.02/$ in the previous week, this week the rupee closed at 83.166/$. The Indian rupee is closely linked to the dollar index, but that was not the case time this time around. In the current week, the dollar index fell sharply to the 101 levels, especially after the PCE inflation came in lower at 2.6%. However, what has kept the rupee weak is the fear that the Yen carry trade may start to unwind and that the Red Sea crisis could again force the FPIs to rethink their India investment exposure.

BRENT CRUDE RISES AS RED SEA PREMIUM PICKS UP

The latest week saw a sharp spike in crude prices. After Brent closed the previous week at $76.55/bbl, this week the price of Brent crude closed at $79.07/bbl. 

Date	Price ($/bbl)	Open ($/bbl)	High ($/bbl)	Low ($/bbl)
Nov 27, 2023	79.87	80.16	81.14	79.07
Nov 28, 2023	81.47	80.17	81.97	79.70
Nov 29, 2023	82.88	81.64	82.99	80.72
Nov 30, 2023	80.86	82.62	84.61	80.01
Dec 01, 2023	78.88	80.67	81.54	78.75
Dec 04, 2023	78.03	79.50	79.72	77.52
Dec 05, 2023	77.20	78.10	79.09	77.00
Dec 06, 2023	74.30	77.12	77.65	74.11
Dec 07, 2023	74.05	74.50	75.48	73.60
Dec 08, 2023	75.90	74.63	76.36	74.21
Dec 11, 2023	76.03	75.73	76.50	75.01
Dec 12, 2023	73.24	76.17	76.66	72.86
Dec 13, 2023	74.26	73.26	74.70	72.29
Dec 14, 2023	76.61	74.76	77.35	74.44
Dec 15, 2023	76.55	76.66	77.23	75.29
Dec 18, 2023	77.95	76.80	79.51	75.76
Dec 19, 2023	79.23	78.06	79.67	77.41
Dec 20, 2023	79.70	79.17	80.60	79.07
Dec 21, 2023	79.39	79.00	80.13	77.81
Dec 22, 2023	79.07	79.35	80.37	78.88

Data Source: Bloomberg

The sudden spike in crude oil prices can be attributed to the Red Sea crisis with Houthi rebels firing missiles at ships carrying merchandise through the Red Sea. This is one of the world’s most important trade routes and despite American promise to monitor the trade route, the risks are huge. The oil cargo must pay higher insurance premium or take the route through Cape of Good Hope. Either ways, freight charges are likely to rise sharply. That is being reflected in higher oil prices. Also, weaker dollar is boosting oil prices.

GOLD BOUNCES BACK TO ABOVE $2,050/OZ

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

Date	Price ($/oz)	Open ($/oz)	High ($/oz)	Low ($/oz)
Nov 27, 2023	2,013.64	2,002.78	2,018.14	2,000.67
Nov 28, 2023	2,040.89	2,013.94	2,043.00	2,011.60
Nov 29, 2023	2,044.59	2,041.24	2,052.09	2,035.05
Nov 30, 2023	2,035.75	2,044.80	2,047.59	2,031.84
Dec 01, 2023	2,070.90	2,034.49	2,075.34	2,033.75
Dec 04, 2023	2,029.74	2,071.25	2,135.90	2,020.34
Dec 05, 2023	2,019.42	2,030.15	2,041.33	2,010.02
Dec 06, 2023	2,024.90	2,019.74	2,036.30	2,017.27
Dec 07, 2023	2,028.34	2,025.30	2,039.93	2,020.26
Dec 08, 2023	2,004.49	2,028.24	2,034.07	1,994.81
Dec 11, 2023	1,981.30	2,003.60	2,008.72	1,975.95
Dec 12, 2023	1,979.44	1,981.59	1,996.80	1,977.19
Dec 13, 2023	2,026.39	1,979.74	2,027.55	1,973.09
Dec 14, 2023	2,035.53	2,026.59	2,047.98	2,024.33
Dec 15, 2023	2,018.19	2,035.80	2,045.55	2,015.68
Dec 18, 2023	2,027.00	2,020.09	2,033.71	2,015.99
Dec 19, 2023	2,040.12	2,027.30	2,047.07	2,021.74
Dec 20, 2023	2,029.19	2,040.34	2,043.94	2,029.37
Dec 21, 2023	2,045.49	2,029.44	2,046.07	2,029.44
Dec 22, 2023	2,052.98	2,045.84	2,070.65	2,045.65

Data Source: Bloomberg

Gold prices continued their rally this week climbing from $2,018/oz to $2,053/oz. It now looks like $2,000/oz could be the new support. The big trigger for gold prices this week came from the Fed turning dovish and hinting at 175 bps of rate cuts by end of 2025. The CME Fedwatch is a lot more aggressive but it implies that the opportunity cost of holding gold comes down. The weak dollar means gold prices (being denominated in dollars) automatically get a boost. For now, it looks like all that glitters, is surely gold!