Weekly Musings – CME Fedwatch change for week to June 21, 2024

24 Jun 2024 , 03:30 PM

WHY ADRIANA KUGLER IS OPTIMISTIC ABOUT INFLATION

In the US, it is not just the Fed statement and the Fed minutes that are the key inputs on the trajectory of rates in the US. Even the speeches delivered by the Fed governors during the period are of great importance. In this regard, the big question is whether the Fed will actually embark on rate cuts from September 2024 onwards. For that the one question we need to answer is whether there is room to be optimistic about inflation. In a recent speech, Fed governor, Adriana Kugler, feels that there are 4 strong reasons why we can be optimistic that inflation will come down for good and the Fed may have reasons to take up the first rate cut in September 2024. Here are her 4 justifications for being optimistic about inflation in the US economy.

• Forget about the direction of input costs and demand spikes. The crux of the story is that the average US consumer is becoming a lot more cost conscious and is willing to strike hard bargains to keep their household budgets under control. What is that making Adriana Kugler optimistic about inflation? People are not only putting prices above all else, but are even willing to settle for more economical sizes to keep their budgets under check. Hence, even the price setting by US companies are now moving in tandem with the lower inflation expectations. Companies are cautious that consumers may push back against price hikes, and are avoiding that temptation. Lower income groups are turning a lot more price conscious and that is forcing many companies to offer discounts. The sum and substance of this shift is that value for money approach is driving lower inflation.
• Secondly, Adriana Kugler sees a perceptible and substantive fall in input costs for the US businesses. The tapering of nominal wages is driving input costs lower; which means it is the rate of growth that is slowing, so costs are now lower than the estimates of most companies. Consumers don’t mind lower wage growth as inflation has also come down in tandem, taking care of their real income levels. Apart from the labour story, even the physical input costs are coming down. Forget about commodity costs; even cost of funds continue to be low and despite the spike in interest rates, the companies are able to secure funding at attractive rates of interest.
• Is artificial intelligence (AI) driving productivity gains in a big way. Inflation does not hurt anyone, if it is backed by productivity gains. Adriana Kugler things new-fangled technologies like AI are making a big difference. There is still not much of literature on this trend, but scratch the surface and it is happening. Adriana Kugler feels that IT innovations like artificial intelligence (AI) and machine learning (ML) will redefine the productivity of companies and make them more efficient with same level of resources. In addition, the surge in new company registrations is also an indicator of a strong trend of productivity gains. One has to only look at the rising market cap of NVIDIA to understand why this trend has a lot of truth to it.
• On a self-congratulatory note, Kugler also adds that behind the curtain of criticisms about timing of rate cuts, the reality is that hawkish monetary policy has delivered the goods in the last two years. At this juncture, the 2% inflation target may look elusive, but thanks to hawkish policies, the economy is on track. That means; the current Fed policy of higher for longer, is good enough to move the rate of inflation towards 2%.

For now, Fed members like Adriana Kugler believe there are several reasons to be optimistic about inflation coming down. The process may be gradual, but it does set the tone for the first rate cut in September 2024.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JUNE 14, 2024

Let us start with a recap of the week to June 14, 2024; and how the CME Fedwatch panned out during the week. The undertone of members continues to be hawkish as the last mile inflation remains sticky. Hence, higher for longer, was the theme. Here is how the CME Fedwatch chart looked ahead of the FOMC meeting and the quarterly projections.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.3%	89.7%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	6.6%	61.1%	32.3%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.6%	28.2%	49.7%	19.5%	Nil
Dec-24	Nil	Nil	Nil	Nil	2.1%	23.2%	45.5%	25.4%	3.8%	Nil
Jan-25	Nil	Nil	Nil	1.3%	14.7%	36.6%	33.5%	12.5%	1.5%	Nil
Mar-25	Nil	Nil	0.9%	10.5%	29.7%	34.4%	19.1%	5.0%	0.5%	Nil
Apr-25	Nil	0.4%	5.4%	19.6%	31.9%	27.1%	12.4%	2.8%	0.3%	Nil
Jun-25	0.3%	3.6%	14.4%	27.4%	28.9%	17.8%	6.3%	1.2%	0.1%	Nil
Jul-25	1.7%	8.0%	19.7%	28.0%	24.4%	13.1%	4.2%	0.7%	0.1%	Nil
Sep-25	7.2%	16.0%	25.4%	25.5%	16.7%	7.0%	1.8%	0.3%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers influencing the CME Fedwatch in the week to June 14, 2024; and all of them were very critical inputs.

• The US Fed released its June monetary policy on June 12, 2024. The monetary policy statement was supposed to be a rather routine affair with rates constant. While rates were held at 5.25%-5.50%, there were some interesting cues. The Fed reduced rate cut guidance to just 1 rate cut in 2024, but agreed to aggressive rate cuts in 2025. That came as manna from heaven for the CME Fedwatch, which did get tad aggressive.
• The all-important CPI inflation in the US for May 2024 was put out on the same day as the policy statement. While the core inflation and food inflation tapered, the sharp spike in the energy inflation was the concern. Energy products and energy services saw a sharp spike in inflation. The overall inflation tapered by 10 bps to 3.3% for May 2024; but still remains a good 130 bps away from the eventual target of 2%.
• The other big trigger during the week was the quarterly update for key macros; which was updated for the quarter in June. The June update has pegged higher levels of core inflation and headline inflation in future years, but has kept GDP growth and unemployment projections approximately flat. Rates are expected to be higher for longer. It will be 50 bps higher at 5.1% as of end-2024 and up 20 bps at 2.8% in the long run rate estimates; compared to the previous estimates.

Let us now shift to the actual CME Fedwatch movements in the latest week to November 2024, and the key triggers during the week.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO JUNE 21, 2024

The latest week to June 21, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024. However, this is despite the Fed now guiding for just one rate cut in 2024.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.3%	89.7%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	6.4%	59.5%	34.1%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.3%	25.1%	50.6%	22.1%	Nil
Dec-24	Nil	Nil	Nil	Nil	1.7%	19.9%	44.7%	28.6%	5.1%	Nil
Jan-25	Nil	Nil	Nil	1.0%	12.6%	34.7%	35.1%	14.5%	2.0%	Nil
Mar-25	Nil	Nil	0.7%	8.7%	27.3%	35.0%	21.4%	6.2%	0.7%	Nil
Apr-25	Nil	0.3%	4.5%	17.5%	30.9%	28.5%	14.2%	3.6%	0.4%	Nil
Jun-25	0.2%	2.9%	12.5%	25.8%	29.5%	19.7%	7.7%	1.6%	0.1%	Nil
Jul-25	1.4%	6.7%	17.8%	27.3%	25.6%	15.0%	5.3%	1.0%	0.1%	Nil
Sep-25	6.6%	15.2%	25.1%	26.0%	17.4%	7.5%	2.0%	0.3%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers influencing the CME Fedwatch in the week to June 21, 2024; and all of them were very critical inputs.

• Key FOMC members like Williams and Harker spoke during the week. There was general concern on price levels, although there appears to be optimism building that the worst of inflation may be over. Most Fed members continue to be cautious, but optimistic that inflation would eventually come down, making way for rate cuts in September 2024.
• The API crude weekly stocks will be the key to energy inflation, although oil prices are not always in tandem. Last week, the API reserves saw a drawdown of -2.547 Million barrels. This is lower than expected, but the gist of the story is that oil demand is strong and that is likely to keep crude oil prices around the $85/bbl mark.
• In other key events, the Monetary Policy Report has been submitted to the Congress and there will be a Fed testimony on that. While the Fed balance sheet has stabilized at $7.25 trillion, the Atlanta GDP for Q2 estimates still appear strong at 3.1%.

Inflation is sticky in the last mile and rates are likely to be higher for longer. Data flows are still to give decisive comfort for rate cuts..

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO JUNE 28, 2024

It will be a truncated week in the US with June 19, 2024 being a holiday. There are 3 critical triggers to watch out for in the coming week to June 21, 2024 for CME Fedwatch.

• The third and final estimate of Q1GDP growth will be announced on Thursday in the coming week. In the second estimate it was reduced from 1.6% to 1.3% and for now, the estimate is that the 1.3% growth in GDP for Q1 will be retained.
• The PCE inflation figure for May 2024 will also be announce on Friday in the coming week. This is likely to be about 10 bps lower at 2.6%, but still not giving any decisive trend. There is likely to be a 20 bps fall in the core inflation in the month. It remains to be seen if the PCE inflation makes a case for a September 2024 rate cut.
• An important data point will be the bank stress tests that will be published by the Fed on Thursday. The Stress tests evaluate how resilient the banks are against a spike in rates or a sharp spike in the non-performing assets. The half-yearly stress test is a means of assessing whether the banks in the US are prepared for a worst case scenario..

The big data points in the coming week will, obviously, be the PCE inflation and the GDP growth estimates. That is likely to set the tone for a likely September 2024 rate cut.

CME FEDWATCH EXPECTS WATCHFUL 2024; INDULGENT 2025

Based on the latest flows, how have the probabilities of rate cuts changed in the week. With limited data flows in the week to June 21, 2024, there has not been much of a change in the probabilities, other than some minor shifts. The tone was already set after the Fed policy statement and the inflation last week. With rate hikes ruled out, let us look at the likely interest rate scenario at the end of 2024 and the middle of 2025.

• Let us first look at the rate cut possibilities in 2024. Currently, the CME Fedwatch has assigned a 66% probability that the first rate cut will happen in September; almost the same as last week. However, by December 2024, the CME Fedwatch is pencilling in a 66.3% probability of 2 rate cuts, lower than last week, but higher than Fed guidance.
• What about the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in an 78.6% probability of overall 4 rate cuts, which is quite aggressive. In addition, the CME Fedwatch is also assigning a probability of 73% probability of 5 rate cuts by September 2025. However, these stories will evolve better only after the actual rate cuts start, supposedly, in September 2024. The bottom line is that the CME Fedwatch is expecting that even if Fed restricts itself to 1 rate cut in 2024, it will compensate through greater aggression in 2025. Even Fed had hinted at that.

For now, the hawks in the Fed still have the upper hand. For the Fed, the choice is clear. With robust GDP growth and elevated levels of consumption, it can afford to err by being too cautious. It has nothing to lose by keeping rates where there. However, getting dovish too soon has its own risks. A lot will depend on how the Fed weighs its options in the next 3 months, if the September 2024 rate has to become a reality.