Weekly Musings – CME Fedwatch change for week to April 26, 2024

30 Apr 2024 , 10:02 AM

WHY DID US Q1 GDP DISAPPOINT THE STREET?

In terms of the impact on the CME Fedwatch during the week, there were two major data points. Let us focus on why the first data point, First advance estimate (FAE) of Q1-2024 GDP did not live up to the mark. At 1.6% GDP growth, the first quarter growth estimate for the US economy was nearly 80 bps lower than the street expectation and a full 120  bps lower than the Atlanta Fed GDP prediction. Also, on a sequential basis, the GDP growth was sharply lower compared to 3.4% in Q4-2023 and 4.9% in Q3. Of course, there are 2 more estimates to come for first quarter GDP, but the underlying trend is unlikely to change drastically. The table below has the break-up of the 1.6% GDP growth for Q1.

GDP Data	Q4-2022 YOY (%)	Q1-2023 YOY (%)	Q2-2023 YOY (%)	Q3-2023 YOY (%)	Q4-2023 YOY (%)	Q1-2024 YOY (%) #
GDP Overall	2.6	2.2	2.1	4.9	3.4	1.6
GDP – Goods	6.2	-1.3	0.9	7.3	2.6	-2.4
GDP-Services	2.5	3.2	1.9	2.9	2.8	3.0
Structures	-9.6	8.9	7.7	10.0	10.4	6.5
Auto O/P	-1.2	14.7	15.4	-7.1	-21.8	-6.4
GDP Ex-Auto	2.7	1.9	1.7	5.2	4.2	1.8
Non-farm GVA	2.8	1.8	2.0	5.8	3.8	1.3

Data Source: US Bureau of Economic Analysis (BEA) - # First Estimates

What triggered the fall in GDP growth to 1.6% in Q1. Let us break it up in to goods and services.

• The growth in GDP for physical goods dipped into the negative in Q1-2024 at -2.4%. This is sharply lower than the last 2 quarters, and it looks like the direct outcome of the constraints posed by the Red Sea crisis, which has deeply impacted trade in goods.
• GDP Services continued to be robust rising from 2.8% to 3.0% sequentially, as the geopolitical risks did not have much of an impact. In fact, growth in services was at its highest level in the last 4 quarters.
• Auto sector still contributed the biggest chunk to the slowdown in goods, but more industrial sectors have also joined in this month. That is evident when we look at the non-farm GVA growth falling from 5.8% to 1.3% over the last 2 quarters.

However, the real pressure point on the real GDP came from the higher inflation factor, including core inflation. Between Q4-2023 and Q1-2024, the nominal GDP growth only fell from 5.3% to 4.9%. However, in this period, the spike in the inflation factor led to a much sharper fall in real GDP. That is broadly in sync with the Fed concerns that the inflation monster was far from conquered.

FORGET ABOUT RATE CUTS FOR NOW

Ironically, the first to acknowledge this shift was the CME Fedwatch. It had started about 4 months back with a lot of enthusiasm and optimism that rate cuts would be rapid and front-ended. Nothing of that kind happened. Now, even the CME Fedwatch is reconciled to just about one rate cut in 2024. Even that is now expected to happen around September or even after that. In the recent past, while Powell has played a more diplomatic game, hawks like Christopher Waller and Michelle Bowman had been warning about rushing into rate cuts.

They preferred holding rates higher for a longer period of time. The message seems to be, “Forget about rate cuts.” That is not even the debate now! The CME Fedwatch appears to believe that the first rate cut by the Fed would happen in September, although even that is not certain. However, CME Fedwatch is only factoring 1 rate cut in 2024. In fact, the CME Fedwatch has now turned so conservative that it does not even want to make any serious estimate beyond March 2025. The best case scenario of 3 rate cuts by end of 2025.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED APRIL 19, 2024

The week to April 19, 2024 was marked by Fed talk veering towards holding rates higher for longer and that was reflected in the rising US bond yields and the dollar index. 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	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 was the API crude weekly inventories report. API inventories had 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. That enabled the crude price to stay under $90/bbl and also kept the energy inflation in check in the US.
• There were several influential voices in the week. These include Bostic, Mester and Neil Kashkari. The consensus among the Fed members was that the best case would be one rate cut in 2024. Surprisingly, even traditional doves like Neil Kashkari are now worried about inflation and advocate a more calibrated approach to rate cuts.
• The one thing that was closely tracked in the week was the US dollar index. After the US Fed almost made it clear that there would be just rate cut in 2024, the dollar index veered towards its critical high of 107. Currently, it is still at 106 levels.

Let us turn to major triggers for the CME Fedwatch in the current week to April 26, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO APRIL 26, 2024

The latest week to April 26, 2024 saw the CME Fedwatch veering towards just 1 rate cut in 2024; with rather ambivalent probabilities. The big data flows in the week were the first advance estimates of Q1-2024 GDP and the March 2024 PCE inflation update.

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	2.4%	97.6%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.2%	10.8%	88.9%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.6%	28.6%	68.7%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	12.5%	43.8%	42.6%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.2%	3.6%	19.6%	43.6%	33.0%
Dec-24	Nil	Nil	Nil	Nil	0.1%	1.5%	9.8%	28.8%	39.5%	20.2%
Jan-25	Nil	Nil	Nil	Nil	0.5%	3.9%	15.3%	31.9%	33.9%	14.4%
Mar-25	Nil	Nil	Nil	0.2%	1.8%	8.1%	21.4%	32.7%	26.7%	9.1%
Apr-25	Nil	Nil	0.1%	0.6%	3.5%	11.7%	24.5%	31.1%	22.0%	6.6%
Jun-25	Nil	Nil	0.3%	1.8%	6.9%	17.1%	27.2%	27.2%	15.5%	3.8%

Data source: CME Fedwatch

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

• The GDP (FAE) forecast for Q1-2024 came in sharply lower at 1.6%. This was sharply lower than the 2.4% street expectation and 2.8% expectation of Atlanta Fed GDP. Even in sequential terms, the real GDP growth was sharply lower. However, the real concern was that this GDP growth challenge was triggered by sharply higher inflation.
• The other major data point of PCE inflation was up 20 bps at 2.7%. Now, PCE inflation has risen by 30 bps in the last 2 months. The pressure on PCE inflation in March came from food inflation, energy inflation and core inflation. The bigger worry is that the sustained gains from falling core inflation may have finally saturated.
• API crude stocks once again disappointed in the week. For the week, the API crude stocks were expected to increase by 1.800 Million barrels. Instead, it fell by -3.230 Million barrels, a factor that led the Brent Crude to spike to above $89/bbl on Friday. Clearly, the risks to energy inflation remain a major risk for the US economy.

Let us turn to the key triggers for the CME Fedwatch in the coming week to May 03,2024 and how the CME Fedwatch is likely to shape up?

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO MAY 03, 2024

There are 3 critical triggers to watch out for in the coming week to MAY 03, 2024 with reference to CME Fedwatch.

• The big data point in the coming week will be the Fed policy statement on May 01, 2024. While no rate action, or even talk about rate action is expected in the coming week, the Fed may reduce its guidance for rate cuts to just one rate cut in 2024. That would make things a lot clearer to the markets.
• API crude inventories will again be in focus in the coming week, especially after the inventories fell sharply by -3.230 Million barrels in the previous week. The pressure on oil prices is likely to continue and, with Brent at $89.4/bbl, we could see the energy inflation again come under stress in the coming week.
• The 2 factors thing that will be closely tracked in the coming week will be the US bond yields and the US dollar index (DXY). Dollar index is tantalizingly close to its critical breakout level of 107, while bond yields are in the vicinity of 4.7%. Any hawkish signals from the Fed in its policy statement this week could spike both these indicators.

Let us finally turn to how the CME Fedwatch is now leading the Fed statements in terms of adopting a more hawkish view of the trajectory of interest rates.

CME FEDWATCH NOW PENCILS JUST ONE RATE CUT IN 2024

As of the end of last week, the CME Fedwatch is pencilling in a 60% probability that the Fed would only cut rates by 25 bps in year 2024. Also, the expectation is that the Fed may undertake an experimental rate cut of 25 bps in September and wait after that. With the surge in PCE inflation last week and the sharp fall in real GDP (again due to high inflation), it now seems obvious that rate cuts are off the table for now. The elevated inflation data, rising oil inflation risks from West Asia and the hawkish noises coming from Fed Speak have left a deep impact on Fed rate cut probabilities.

• Let us first look at the probabilities on the upside. After the GDP data, there was a brief period when the CME Fedwatch anticipated the remote possibility of a rate hike in this year, but that is off the estimates for now. For now, it looks like the Fed rates have peaked at 5.25%-5.50%. Any move from here on, would only be on the downside.
• What about the downside consensus on the rate cuts side? 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. Now, the CME Fedwatch is pencilling in a 60% probability that there would be just one rate cuts in 2024, along with a 40% probability of 2 rate cuts. But, clearly, that looks more like hope and less like expectation. In fact, the CME Fedwatch is assigning a probability of 21% that the Fed rates will maintain status quo till December 2024; which means no rate cuts in 2024.

For the time being the FOMC members are willing to wait and watch, rather than jump into rate cuts. Probably,  the Fed may have jumped the gun in assuring 3 rate cuts in 2024. That looks increasingly unlikely. The moral of the story is that; FOMC members are in no hurry to cut rates and the CME Fedwatch has already reconciled to the new reality!