Weekly Musings – CME Fedwatch change for week to April 19, 2024

22 Apr 2024 , 09:38 AM

NOT MUCH PROGRESS ON INFLATION, SAYS JEROME POWELL

A lot seems to have changed in the enthusiasm of the Fed about rate cuts. About 3 months back, the Fed had guided for 3 rate cuts in 2024 and 4 rate cuts in 2025t. Later that was toned down to 3 rate cuts in 2024 and another 3 rate cuts in 2025, which was still an extremely optimistic scenario. Things changed in recent weeks as GDP continued to be robust despite higher rates of interest, while inflation started to move up. Amidst these data points, the energy basket came under pressure as Brent Crude moved towards $90/bbl. The same Jerome Powell, who had assured the markets about 3 rate cuts in 2024 less than a month ago, is now reconciling to just 1 rate cuts in 2024. What led to this sudden shift in the stance of the Fed. In short, rate cuts are almost ruled out in the foreseeable future.

The entire Fed decision to cut rates was predicated on the confidence that the US inflation was inexorably moving towards the 2% mark. That kind of confidence is not there for the Fed today, which means rate cuts could take longer than expected. Apart from robust GDP and labour data, the US inflation is getting tougher to tame. In this latest cycle, the persistently high levels of Fed rates have not been instrumental in bringing down the rate of inflation drastically. With the US economy growing even in the midst of high rates, the Fed sees no hurry to cut rates at this juncture and risk the return of inflation.

At a recent speech delivered by Jerome Powell at the policy forum for US-Canada economic relations, Powell underlined that since the inflation levels had not fallen fast enough, the current policy stance may stay for a longer period of time. If higher inflation is making the Fed diffident about giving too much of interest rate leeway; the robust growth and labour data is making the Fed confident that, since growth is robust, the Fed can achieve its goals on inflation control, without cutting interest rates. Powell also pointed out that most of the recent statements by Fed members had pointed to the fact that interest rates may stay put till inflation showed signs of petering. That was not yet visible.

WHEN BEING EARLY IS NOT BEING SMART

It may be recollected that since July 2023, the Fed has kept its benchmark interest rate in a target range between 5.25%-5.50%. This is the highest level in 23 years and was last seen during the IT shock at the turn of the millennium. More than the timing of the rate cut, Jerome Powell and his team are worried about the risks of moving too early. When it comes to cutting rates, the view is that it may not be a smart move to rush through with rate cuts. One reason is that, should the inflation monster rear its head again, it becomes a lot more difficult to undo the dovishness. Hence the Fed would prefer to err on the side of caution.

The key lies in the words “Greater Confidence.” The Fed had already warned that the last mile would be the toughest in the inflation control process and that is visible in recent months. The risk that the Fed sees in cutting rates early is that the surge in liquidity and easy money could push up inflation rapidly. That could offset most of the gains from the fall in core inflation as an outcome of the supply chain constraints getting eliminated. Let us now turn to the recap of the previous week.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED APRIL 12, 2024

The week to April 12, 2024 was marked by the spike in consumer inflation and the MPC minutes; both of which gave adequate indications that rate cuts were not on the Fed agenda for now. CME Fedwatch was betting on just 2 rate cuts in 2024.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	5.9%	94.1%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.4%	26.9%	71.7%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.6%	11.4%	44.5%	43.5%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.3%	5.6%	26.6%	44.0%	23.5%
Nov-24	Nil	Nil	Nil	Nil	0.1%	1.6%	11.0%	31.2%	38.7%	17.4%
Dec-24	Nil	Nil	Nil	Nil	0.8%	6.2%	20.9%	34.8%	28.3%	8.9%
Jan-25	Nil	Nil	Nil	0.3%	2.6%	11.1%	25.5%	32.7%	21.9%	5.9%
Mar-25	Nil	Nil	0.1%	1.3%	6.4%	17.6%	28.7%	27.8%	14.7%	3.3%
Apr-25	Nil	Nil	0.5%	2.8%	9.7%	20.8%	28.5%	24.0%	11.4%	2.3%
Jun-25	Nil	0.2%	1.6%	6.0%	14.8%	24.3%	26.4%	18.2%	7.2%	1.3%

Data source: CME Fedwatch

There were 4 critical data points in the week to April 19, 2024 with reference to CME Fedwatch.

• Consumer inflation set the agenda for CME Fedwatch. The March CPI inflation surged 30 bps to 3.5%. US inflation is now a full 150 bps above the target rate of 2%. It was once again a problem with the last mile, but the obvious inference is that rate cuts are going to be off the agenda for now; at least till inflation gets much closer to the 2% target.
• FOMC minutes of the March Fed meet were published in the week. The Fed continued to be sceptical about rate cuts. Members of the FOMC were quite emphatic that there was no justification for rate cuts at this juncture. The minutes showed that the FOMC members were concerned about rising inflation, especially amidst the oil crisis.
• Talking of oil, it continued to hover around $90/bbl, and is contributing to energy inflation in a big way. IN addition, the dollar index (DXY) jumped from 104 to 106 levels during the week. The strength in the dollar index is also likely to put pressure on other currencies. US continues to be wary of imported inflation.

Let us turn to how the CME Fedwatch was influenced by the flow of data in the latest week.

CUT TO THE PRESENT: CME FEDWATCH IN WEEK TO APRIL 19, 2024

The latest week to April 19, 2024 saw the CME Fedwatch veering towards just 2 rate cuts in 2024; with more ambivalent probabilities. The big data flows in the week were the Fed Speak cues. The expectation was at 2 rate cuts in 2024 and 3-4 rate cuts by June 2025.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	3.2%	96.8%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	16.2%	83.4%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	5.0%	35.6%	59.3%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	2.1%	17.2%	45.1%	35.6%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.5%	5.5%	23.6%	42.9%	27.4%
Dec-24	Nil	Nil	Nil	Nil	0.2%	2.6%	13.2%	31.8%	36.3%	15.8%
Jan-25	Nil	Nil	Nil	0.1%	0.9%	5.7%	18.5%	33.1%	30.4%	11.3%
Mar-25	Nil	Nil	Nil	0.4%	2.9%	11.0%	24.5%	32.0%	22.6%	6.6%
Apr-25	Nil	Nil	0.1%	1.1%	5.2%	14.9%	26.7%	29.3%	18.0%	4.7%
Jun-25	Nil	0.1%	0.6%	2.8%	9.3%	19.8%	27.8%	24.5%	12.4%	2.7%

Data source: CME Fedwatch

There were 3 critical triggers that influenced the CME Fedwatch in the week to April 19, 2024 in terms of key swing factors.

• The major data point this week will be the API crude weekly inventories report. Last week, the API inventories increased by 4.090 Million barrels on top of a spike in the previous week. That is a good sign amidst the worsening tensions in the Middle East and West Asia. The spike in oil inventories during the week, subdued oil below $90/bbl.
• There are several influential voices to speak in this week. These include Bostic, Mester and Neil Kashkari. The underlying theme was that it was too early to cut rates and the last mile of inflation had to be handled more carefully. All the three speakers did ore foresee more than 1 rate hike in the year 2024.
• The one thing that was closely tracked in the week was the US dollar index. Last week, the dollar index rallied sharply to 106 levels and it remained at the same level. In its entire history, the Dollar Index has crossed 107 levels only thrice. Hence, the DXY is at a crucial level, which could be like a break or break situation.

Let us finally turn to the major triggers for the CME Fedwatch in the coming week.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO APRIL 26, 2024

There are 3 critical triggers to watch out for in the coming week to April 26, 2024 with reference to CME Fedwatch.

• The first quarter US GDP estimate for 2024 will be released on Thursday this week. The US GDP growth is likely to be at 2.5%, which is robust enough. However, any further uptick in GDP growth only makes the chances of a rate cut more remote.
• On the coming Friday, the PCE inflation is to be announced. The CPI inflation for March had spiked by 30 bps for March and the spill-off would be there on PCE inflation also. The PCE inflation is the benchmark for the Fed to decide on rates and if that figure is higher, as it is likely to be, it is likely to push back rate cuts further.
• The one thing that will be closely tracked in the week will be the US dollar index and the US bond yields. This week, the dollar index rallied beyond 106 levels. In its entire history, the Dollar Index has crossed 107 levels only thrice. Apart from the DXY, the US bond yields acts as the global borrowing benchmark and higher yields pushes off rate cuts.

Let us finally turn to how the CME Fedwatch has not only converged with the Fed viewpoint, but has also become more hawkish than the Fed statements.

CME FEDWATCH NOW EXPECTS JUST 1 RATE CUT IN 2024

The last 5 weeks have been an absolute see-saw. In recent weeks, the PCE inflation, CPI inflation and the robust GDP numbers have all pointed to the likelihood that rate cuts could be delayed. One has to await the GDP and PCE inflation data next week. It is not yet clear when the rate cuts will start in the US, but markets are reconciling themselves to anywhere between 1-2 rate cuts in 202r4. For now, September seems to be the earliest when rate cuts are likely to commence in the US markets. The elevated inflation data, rising oil inflation risks from the Middle East and the hawkish noises coming from Fed Speak have left a deep impact on the Fed rate cut probabilities.

• Let us first look at the probabilities on the upside. There appears to be almost a consensus between the Fed and the CME Fedwatch that rates have peaked in the range of 5.25%-5.50%. That is something CME Fedwatch has been hinting for some time and now even Fed statements appear to concur with this view.
• On the downside, CME Fedwatch has not only aligned itself with the Fed viewpoint, but the CME Fedwatch is starting to look more hawkish than the Fed statement indications. Now, the CME Fedwatch is pencilling in a 51% probability that there would only be 1 rate cuts in 2024, along with a 50% probability of 2 rate cuts. In fact, the CME Fedwatch is assigning a probability of 16% that the Fed rates will maintain status quo till December 2024. The longer term projections are likely to be less credible, especially if you consider the fluid macroeconomic situation; so, they are less of estimates and more of guesstimates.

What did we gather from the language of the Fed and the subtle shifts in the rate cut probabilities assigned by the CME Fedwatch? Fed and its members are willing to wait and watch, rather than jump into rate cuts. Probably,  the Fed may have acted prematurely in assuring 3 rate cuts in 2024. That looks increasingly remote. Clearly, the FOMC members are in no rush to cut rates and the markets are gradually reconciling to the new reality.