Weekly Musings – CME Fedwatch for week to October 04, 2024

7 Oct 2024 , 04:26 AM

SORRY, THE US ECONOMY DOES NOT APPEAR TO BE SLOWING

Ever since the US unemployment figure touched 4.3% in July 2024, there have been persistent talks about a hard landing. Now, for the layman, hard landing refers to a situation where too much of hawkishness (rate hikes) by the central bank leads to compression in credit, consumer demand and, therefore, economic growth. Hard landing is the risk that too much of hawkishness may slow the economy. That was the worry in the US for quite some time after the Fed had hiked rates by 500 points between March 2022 and July 2023. For a fairly long time, the US managed to have performed a miracle. They had brought down inflation ruthlessly by hiking rates, without impacting growth. That was till early August 2024, when unemployment showed a spike to 4.3%.

However, in the US, it is not just the unemployment data that is a sign of a likely recession. It has to be looked at in the context of average GDP growth and the yield spread between the 2-year bond and the 10 year bond. The unemployment rate, which spiked to 4.3% in July, has moderated to 4.2% and 4.1% in August and September. While 4.3% may have been an aberration, it was also a warning signal that growth could slow if monetary tightness was not relaxed. That eventually led to the FOMC cutting rates by a full 50 bps on September 18, 2024. However, that still does not address whether the risk of hard landing stays, or whether the ghost of a slowdown has been exorcised for now.

Let us look at the GDP data first. As of how we have full data for the first two quarters of calendar 2024. In Q1-2024, the US economy reported sharply lower GDP growth at 1.4%. This had been one of the triggers for the slowdown debate. This level was starkly lower compared to last year’s Q3 growth at 4.9% and the Q4 growth in US GDP at 3.4%. However, the final estimate of GDP reported by the US Bureau of Economic Analysis (BEA) in end September shows the US economy growing by a healthy 3.0% in Q2-2024. The Q1 growth was upgraded to 1.6% while the Q3 and Q4 growth of previous year were cut, leading a smoother trend curve. The Atlanta Fed GDP estimates for Q3 at 2.5% to 3.0% GDP growth also hints at full year 2024 growth closer to 2.5%; much higher than Fed estimates.

The other indicator of recession is the yield spread between the 2-year and 10-year bonds. The positive yield spread is when the 10-year yield exceeds the 2-year yield. However, when there is heightened uncertainty investors prefer the short end and avoid the long end of the yield curve. That is when the yield curve inverts. The yield spread (10Y-2Y), was negative for most of last year, but has turned positive since the start of September 2024. The spread of 15 bps is lower than the long term average of 86 bps, but it surely rules out a slowdown.

In the US, the final call on whether or not it is recession is taken by the Business Cycle Dating Committee of the National Bureau of Economic Research. The spectre of slowdown has not entirely been discounted, so dovishness may be here to stay.

RECAP – CME  FEDWATCH FOR PREVIOUS WEEK ENDED SEPTEMBER 27, 2024

Let us start with a recap of the week to September 27, 2024; and how the CME Fedwatch panned out during the week. This was a week after the Fed cut rates by 50 bps, so the dovishness of the Fed and the sense of celebration is evident in the probability distribution of rate cut expectations.

Fed Meet	200-225 #	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	53.3%	46.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	28.9%	49.7%	21.3%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	8.8%	35.3%	41.1%	14.9%	Nil	Nil
Mar-25	Nil	Nil	Nil	1.8%	14.1%	36.4%	35.8%	11.9%	Nil	Nil	Nil
May-25	Nil	Nil	1.4%	11.9%	32.4%	35.9%	16.2%	2.1%	Nil	Nil	Nil
Jun-25	Nil	0.9%	8.2%	25.2%	34.7%	23.1%	7.1%	0.7%	Nil	Nil	Nil
Jul-25	0.3%	3.5%	14.2%	28.5%	30.6%	17.5%	4.9%	0.5%	Nil	Nil	Nil
Sep-25	1.3%	6.4%	18.1%	29.1%	27.1%	14.1%	3.7%	0.4%	Nil	Nil	Nil
Oct-25	2.3%	8.1%	19.7%	28.8%	25.1%	12.5%	3.2%	0.3%	Nil	Nil	Nil
Dec-25	2.7%	8.8%	20.2%	28.6%	24.4%	12.0%	3.0%	0.3%	Nil	Nil	Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

Here is a quick picture of how the rate cut probabilities panned out after the PCE inflation data for August 2024. There were some doubts about the extent of dovishness after the robust GDP data, but the 30 bps fall in PCE inflation for August set these doubts to rest. There were 3 key data points in the week.

• The third and final estimate of Q2 GDP was announced by the US BEA during that week. The second estimate had pegged the Q2 GDP growth at 3.0% and that was sustained in the third estimate too. This largely gels with the estimates put out by the Atlanta Fed GDP on Q3 GDP for the US economy at approximately 3.0% to 3.1%.
• A day after the GDP data announcement, the US BEA also announced the PCE inflation for August. The PCE inflation (based on personal consumption expenditure) fell sharply from 2.5% in July to 2.2% in August. However, core PCE inflation was up by 10 bps and most of the fall in inflation was an outcome of sharply lower crude oil prices. That can may have changed in the last couple of weeks.
• There were two big speeches in the week by Michelle Bowman and Adriana Kugler. At the Kentucky Bankers Association, Michelle Bowman held that Fed would have been better off with a 25 bps rate cut, as a 50 bps cut had sent out wrong signals on growth and inflation. However, Adriana Kugler, supported the 50 bps rate cut, since front loading of rate cuts was the best way to show Fed aggression in averting a hard landing.

Let us move to the latest week to October 04, 2024 and look at the key driving factors.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO OCTOBER 04, 2024

The latest week to October 04, 2024 saw the CME Fedwatch continue to factor in 3-4 rate cuts in 2024, but also toned down to just 200 bps rate cut by end of 2025.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	97.4	2.6%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	17.7%	80.2%	2.1%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	14.8%	69.8%	15.1%	0.3%	Nil
Mar-25	Nil	Nil	Nil	Nil	Nil	11.8%	58.8%	26.0%	3.3%	0.1%	Nil
May-25	Nil	Nil	Nil	Nil	6.7%	38.5%	40.2%	13.1%	1.5%	Nil	Nil
Jun-25	Nil	Nil	Nil	3.9%	25.2%	39.5%	24.4%	6.3%	0.6%	Nil	Nil
Jul-25	Nil	Nil	1.3%	10.9%	29.9%	34.5%	18.5%	4.5%	0.4%	Nil	Nil
Sep-25	Nil	0.4%	4.6%	17.5%	31.5%	29.0%	13.6%	3.1%	0.3%	Nil	Nil
Oct-25	0.1%	1.4%	7.6%	20.8%	30.9%	25.4%	11.1%	2.4%	0.2%	Nil	Nil
Dec-25	0.4%	2.7%	10.4%	22.9%	29.8%	22.4%	9.3%	2.0%	0.2%	Nil	Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

The week to October 04, 2024 will be dominated by the US unemployment numbers to be announced on Friday. There were 3 key data points in the week gone by.

• The US unemployment data for September was announced by the US Bureau of Labour Statistics (BLS) on Friday October 04, 2024. In the last 2 months, the rate of unemployment had spiked to 4.3% and 4.2% respectively. In absolute terms, the number of unemployed have been the same. For September 2024, the unemployment rate came down further to 4.1%. The Fed is of the view that an unemployment level of around 4% is consonant with inflation target of 2%, although the eventual target would be to maintain inflation at 2% and unemployment at close to 3.5%, which is also called the level of full employment in the US.
• The all-important OPEC meeting concluded without any decision on production quotas. For now, the existing output would continue with the OPEC insisting on full conformity with these targets by all permanent and temporary members. For now, the OPEC may just stay in the sidelines as the geopolitical risk has already spiked up the price of crude and it does not have to tinker too much on the supply side. More so, since Iranian supply is supposed to be the X-factor due to the ongoing fracas with Israel.
• There were important Fed speeches delivered by Jerome Powell, Michelle Bowman, and Raphael Bostic in the week. It may be recollected that, in the FOMC vote, Michelle Bowman was the only dissent vote, but clearly there would have been a larger number of members would have been ambivalent about the extent of rate cuts. For now, barring Bowman, other members have only spoken in favour of the 50 bps rate cut and promised to maintain the trajectory in coming months also.

Let us finally turn to the big story of how news flows are likely to impact the CME Fedwatch in the coming week.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO OCTOBER 11, 2024

The coming week to October 11, 2024 will be dominated by the FOMC minutes and the announcement of the consumer inflation by the US.

• On October 09, 2024, the minutes of the September 18, 2024 FOMC minutes will be released. The Fed had cut rate by 50 bps in the September FOMC meet and had also guided for more rate cuts. The FOMC minutes will give a precise idea of how many members were positive about 50 bps rate cut, how many were sceptical, and how many sat on the fence. The dot plot of the members was also evident in the long term projections. However, there would be a lot more interest in understanding why Michelle Bowman was the only dissent vote in the FOMC meet..
• The US consumer inflation is likely to be announced on October 10, 2024. For the month of September, the US consumer inflation is expected to fall by another 20 bps to 2.3%. It may be recollected that the PCE inflation for August, announced towards the end of September had seen a sharp fall from 2.5% to 2.2%. If the consumer inflation also falls to around 2.3%, as expected by Bloomberg estimates, then the road would be clear for 50 bps rate cut in this year and another 100 bps in the coming year.
• There are two more data points that will be of interest in the coming week. The EIA inventories saw an accretion of 3.889 Million barrels last week, against the expectation of a sharp drawdown. Clearly, the US has been using lower oil price levels to replenish its crude inventory. However, with the Brent crude prices spiking to above $78 in the current week and rising geopolitical risk, there is a possibility that this week may again see drawdowns. Also, the US Fed balance sheet could see a dip below $7 Trillion in the coming week after a long break.

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

RATES TRAJECTORY – IT WILL BE FRONT-LOADING OF RATE CUTS

The Fed has clearly opted for front loading of rate cuts and it wants to give a message that the central bank means business and can act decisively, either ways. Some of the recent data flows have been conducive to dovish rates. The PCE inflation for August fell by 30 bps to 2.2%, while the unemployment rate also fell further to 4.1%. The rate of unemployment is at a sweet spot where action is required, but also conducive to further rate cuts. This level of unemployment corresponds with 2% inflation, so the Fed is apparently on the right track. Of course, the strife in West Asia is getting worse by the day. In the last few weeks, the US has gained from lower crude prices and that may be changing. Rising oil prices have the potential to be inflationary.

Here is a quick look at how the rate cut probabilities panned out after the unemployment data for September 2024 at 4.1% was factored in on Friday. If there were some doubts about the extent of front-loading of rate cuts in the light of the strong GDP data; the sharply lower PCE inflation and the neutral level of unemployment almost hint at more rate cuts to come. Now for the rate cut trajectory as per CME Fedwatch.

• With the September rate cut of 50 bps done for now, the focus shifts to November and December FOMC meets. The CME Fedwatch gives a probability of 97.4% to 25 bps rate cut in November 2024; with anything beyond that not on the radar.
• What about the first milestone of December 2024? By then, there is 97.9% probability of total 50 bps rate cut (100 bps in all). Also, there is a small probability of 17.7% for an additional 75 bps rate cut. So, it is most likely 100 bps from the peak and remotely 125 bps of rate cuts by the end of December 2024.
• Let us turn to June 2025 milestone. The CME Fedwatch is assigning 93.1% probability for overall 150 bps rate cuts from the peak and 70.6% chance for 175 bps rate cut from the starting point of the cycle.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 88.5% probability for 175 bps of rate cuts from the peak and a high probability of 66.2% for 200 bps of rate cuts by December 2025. So, it looks very likely that the US Fed rate could settle at (3.25%-3.50%) by close of December 2025.

Will the Fed adhere to such an aggressive time table? That looks like the most likely path ahead, unless inflation spikes sharply due to the oil price effect. Then the equations for the US Federal Reserve could change rapidly. For now, it looks like 200 bps rate cut by end of 2025 looks to be on the cards.