Weekly Musings – CME Fedwatch change for week to August 23, 2024

25 Aug 2024 , 08:46 AM

KEY TAKEAWAYS FROM THE FOMC MINUTES

During the previous the Federal Reserve published the minutes of the July 31, 2024 meeting of the Federal Open Markets Committee (FOMC) on August 21, 2024. The consensus was increasingly veering towards a rate cut in September, although some sections of the hawks continue to believe that it would be wiser to attempt rate cuts by end of 2024. Here are our key readings from the FOMC minutes.

• Although the approval for rate cuts is still conditional, it now look very likely that the Fed will embark on its first rate cut on September 18, 2024. Of course, the view was still clothed in caution; “if data continued to come in as expected, it would be appropriate to ease policy at the next meeting.” For now, the CME Fedwatch has already pegged a 100% probability for the first rate cut in September and is pencilling 3-4 rate cuts by end of December 2024. The FOMC members consider rate cuts in September more likely.
• The Fed members, including Jerome Powell, have not entirely give up the data anchor. The cautionary statement still is that, “the data must continue to be in conformity with a rate cut.” That means growth cannot surge and the unemployment cannot be too low as both these factors would lead to a spurt in consumption spending and offset the efforts taken till date to control inflation. Hence, the data condition continues to be real. That was one of the reasons the Fed did not cut the rates in July itself.
• FOMC has underlined two factors which could trigger the proposed rate cut in September. Firstly, there had been substantial progress on inflation which was a positive trigger for rate cuts. Both CPI inflation and PCE inflation are moving steadily towards the 2% mark. On the other hand, the growth scare created by the July labour data was another factor, especially the unemployment rate spiking to 4.3%.
• The members of the FOMC admitted that there was a difficult choice was developing for the Fed on macro data. For instance, the risks to the inflation goal had decreased while the risks to the employment goal had gone up sharply. The good thing is that both these macro triggers can be addressed with the same solution; by cutting rates. In a sense, this dual data dilemma could push the FOMC into a rate cut in the September meet.
• For now, the members of the Fed are only talking about anything beyond September and the decision to cut rates is limited to September and to just 25 basis points. There is no long term trajectory for rates that the Fed has provided, or is likely to provide, beyond September 2024. On the other hand, the market driven CME Fedwatch is amazingly optimistic on rate cuts and is factoring 3-4 rate cuts in 2024 itself. If you consider the period till the end of 2025, then the CME Fedwatch is pencilling anything between 7-9 rate cuts; adding up to 175 bps to 225 bps. If that turns out to be correct (albeit doubtful), the US economy could have rates at around 3% by end of 2025.
• There is one area of concern for the Fed. As of now, the data on inflation appears to be moving steadily down towards the 2% mark. That is something the Fed can rely on to cut rates. However, the labour data has seen unemployment spike only in July. It remains to be seen if the normalization of labour data is sustained or just a flash in the pan. There is also the concern of growth, with the US GDP growth bouncing from 1.4% in Q1-2024 to 2.8% in Q2-2024. It is likely that the labour data and even the retail sales data may be better than expected; as subsequent data points have indicated. While, that assuages fears of hard landing it means rate cuts could be limited to just one for now.

Beyond the debate, lies the action point. We have to wait and watch if the Fed actually cuts rates in September and the outlook it provides. Past experience has been that when the CME Fedwatch oversteps the Fed outlook, it is the CME Fedwatch falls in line eventually.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED AUGUST 16, 2024

Let us start with a recap of the week to August 16, 2024; and how the CME Fedwatch panned out during the week. By the week to August 16, 2024, the markets had more or less crystallized that the first rate cut would happen by September 2024 and also assigned a high probability that 3-4 rate cuts happening in 2024. Here are CME Fedwatch probabilities.

Fed Meet	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	28.5%	71.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.3%	39.4%	53.3%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	2.2%	16.9%	43.6%	37.3%	Nil	Nil
Jan-25	Nil	Nil	Nil	Nil	2.2%	16.7%	43.2%	37.3%	0.6%	Nil	Nil
Mar-25	Nil	Nil	0.1%	.03%	18.3%	43.0%	35.0%	0.6%	Nil	Nil	Nil
Apr-25	Nil	0.1%	1.6%	10.9%	31.1%	39.1%	17.2%	0.1%	Nil	Nil	Nil
Jun-25	0.1%	1.2%	8.5%	25.9%	37.2%	22.8%	4.4%	Nil	Nil	Nil	Nil
Jul-25	0.5%	4.3%	15.8%	30.7%	31.2%	15.0%	2.5%	Nil	Nil	Nil	Nil
Sep-25	3.7%	12.9%	27.0%	31.1%	19.0%	5.6%	0.6%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

Let us look at some of the key triggers that had an impact on the CME Fedwatch probabilities during the previous week to August 16, 2024.

• Amidst the upcoming elections, the Federal budget deficit actually grew nearly 4-fold from $66 Billion to $244 Billion. While it was slightly lower in the latest estimate, the concern is that it could spike the fiscal deficit and make the dollar weaker.
• The US Consumer inflation, reported by the Bureau of Labour Statistics, came in 10 bps lower at 2.9% for July 2024. While the trend is on target, the Fed has expressed concerns that the current consumer inflation is 90 bps away from the target.
• Initial jobless claims for the week were supposed to go up from 234K to 236K. However, that final data came in at 227K, which shows less stress on labour data. The Fed will now await the August unemployment numbers, to see if the stress of July gets repeated.
• There was some relief on oil inventories. After a drawdown of -3.728 Million barrels last week, the week was expected to see a drawdown of -1.900 Million barrels. However, the final number came in positive as accretion of 1.357 Million barrels.

Let us now turn to some of the key triggers for the CME Fedwatch in the current week to August 23, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO AUGUST 23, 2024

The latest week to August 23, 2024 saw the CME Fedwatch continue to factor in 3-4 rate cuts in 2024, but also suggested up to 8-9 rate cuts by December 2025. It is not clearly whether the CME Fedwatch is indulging in estimating inflation or wishful thinking.

Fed Meet	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	24.0%	76.0%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.3%	39.8%	52.9%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	2.4%	17.9%	44.1%	35.7%	Nil	Nil
Jan-25	Nil	Nil	Nil	0.2%	3.8%	20.2%	43.3%	32.4%	Nil	Nil	Nil
Mar-25	Nil	Nil	0.6%	5.4%	22.6%	42.2%	29.2%	Nil	Nil	Nil	Nil
May-25	Nil	0.4%	3.9%	17.3%	36.2%	33.2%	8.9%	Nil	Nil	Nil	Nil
Jun-25	0.3%	2.6%	12.1%	28.9%	34.4%	18.3%	3.5%	Nil	Nil	Nil	Nil
Jul-25	1.3%	6.5%	19.1%	31.2%	27.7%	12.2%	2.0%	Nil	Nil	Nil	Nil
Sep-25	3.5%	10.9%	23.2%	30.0%	22.4%	8.7%	1.3%	Nil	Nil	Nil	Nil
Oct-25	5.8%	13.5%	24.7%	28.3%	19.4%	7.1%	1.0%	Nil	Nil	Nil	Nil
Dec-25	9.0%	16.1%	25.5%	26.2%	16.5%	5.7%	0.8w%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

Looking back, there were 4 major data points that actually served to underscore the intention of the Fed to embark on its first rate cut in September 2024.

• The Fed minutes of the July 31 meeting were published in the week. The message was that the Fed was preparing for its first rate cut in this cycle, after maintaining status quo since July 2023. However, the caveat of supportive data still does exist.
• Speaking at the Jackson Hole Symposium. Jerome Powell declared that the conditions were ripe for the first rate cut. That was welcomed by the markets. However, Powell has not committed to any dovishness beyond that point.
• Initial jobless claims came in at 228K last week, and in this it surged as expected to 232K. This is a clear indication that the labour market is under pressure and one has to correlate this with the final unemployment rate for August, and whether it crosses 4.3%.
• Crude oil inventories as reported by the EIA, continued to be under stress. After an increase in inventories last week, the drawdown was expected at (2.000) Million barrels this week, but the actual drawdown came in sharply higher at (4.649) Million barrels.

Let us now turn to the major triggers for the CME Fedwatch in the coming week to August 30, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO AUGUST 30, 2024

The next week has limited data flows, so it would be more about the micro issues on the macroeconomic front. There are 3 key data points to look out for.

• The second estimate of Q2 GDP will be published by the Bureau of Economic Analysis (BEA) on Thursday. In the first estimate advance estimate, the Q2 GDP growth had bounced from 1.4% to 2.8% sequentially, and that momentum is likely to be sustained.
• The focus will be on the PCE inflation and the core PCE inflation to be announced on Friday. This is the last PCE inflation data before the planned rate cut in the September meet and the Fed would be keen to ensure there are not inflation surprises. Headline PCE and core PCE inflation are expected to be steady at 2.5% & 2.6% respectively.
• The crude oil inventories by the EIA will again be in focus. Last focus there was a sharp drawdown of (4.649) Million barrels. With robust oil demand in the US, the drawdowns are likely to continue, and that is likely to keep the pressure on energy inflation.
• Once again the initial jobless claims will be in focus. Last week, the jobless claims came in as expected at 232K. This will be the last week before the actual unemployment data for August is put out in early September. These will be critical data points as the Fed goes into an expected rate cut in the September FOMC meet.

Let us now turn to the final story of how all these flows added up to influence the CME Fedwatch probabilities in the latest week.

RATES TRAJECTORY – IS THE CME FEDWATCH OPTIMISM FOR REAL?

The one question that comes to mind is whether the optimism of the CME Fedwatch is for real. Now, after the FOMC minutes and the Jackson Hole speech delivered by Jerome Powell, the first rate cut in September is not in doubt. The debate is more on subsequent rate cuts; and that is where the CME Fedwatch appears to be amazingly optimistic. It is true that inflation has fallen and the labour data is showing signs of stress. However, the data is not such that would justify such aggressive rate cuts as the CME Fedwatch is pencilling. There are enough hawks within the Fed like Raphael Bostic and Michelle Bowman, who want to look at rate cuts only towards December 2024. The dichotomy between what the Fed is saying, and what the CME Fedwatch is indicating is quite large. Based on the current data, the Fed looks closer to the real situation. Here are some key takeaways.

• With rate hikes totally off the agenda, we focus on rate cut probabilities in 2024. Currently, the CME Fedwatch has assigned a 100% probability that the first rate cut will happen in September. However, there is increasing evidence of ultra aggression from the CME Fedwatch. The CME Fedwatch assigned 100% probability for 50 bps rate cut in November, while there is a 47.1% probability that there could be 75 bps of rate cuts by November 2024 itself. In addition, the expectation by December 2024 is a 100% probability of 75 bps rate cut and a 64.3% probability of a 100 bps rate cut by December 2024.
• What about the CME Fedwatch expectations for 2025? By June 2025, the CME Fedwatch is factoring in 100% probability of 125 bps of rate cut and 96.5% probability to 150 bps of rate cut by June 2025. We now have CME Fedwatch expectations till December 2025. The CME Fedwatch is assigning a probability of 95% probability of 175 bps of rate cuts by September 2025 and a 77% probability of a 200 bps rate cut by December 2025. This is much quicker than the most aggressive long term estimates by the Federal Reserve.

At the end of the day, the FOMC will have the final say. Fed has hinted at 1 rate cut in 2024; and even here there is a dichotomy. While Powell hinted at a rate cut in September 2024, the hawks are inclined towards cutting rates closer to the end of 2024. It is hard to fathom what Fed has in mind. Clearly, CME Fedwatch may be throwing caution to the winds!