Weekly Musings – CME Fedwatch change for week to May 10, 2024

14 May 2024 , 08:49 AM

NEIL KASHKARI MOOTS RATE HIKE POSSIBILITY

Neil Kashkari, the governor of the Federal Reserve Bank of Minneapolis, has a special place in the Fed. He had a long career at Goldman Sachs, the bluest of blue investment houses in the world. Later, he became a regulator to provide a more granular industry perspective to the Federal Reserve. For a long time, Neil Kashkari has been among the doves. That means; he has been a firm believer that rates should be kept low so that borrowing costs for business can be low and growth can be sustained. Something appears to have changed in the last few months as Neil Kashkari has gravitated more towards the hawks within the Fed like Mester and Bowman. In his recent speech, Neil Kashkari not only ruled out rate cuts till inflation was firmly down; but also hinted that rates could be hiked should inflation pose a persistent problem for the US markets. Here are some key things that Kashkari said.

• Kashkari has actually painted a picture of 3 likely scenarios in front of the Fed. The first and most likely option is that of rates being steady. He sees that as the most likely option since inflation does not show any signs of abating in the next few months, and for the Fed managing price stability and inflation expectations has been sacrosanct.
• The second scenario, the less likely scenario, is that the Fed actually goes ahead and cuts the rates. While the markets are still expecting 3 rate cuts as promised by Fed chair, Jerome Powell, the CME Fedwatch has gravitated towards just 2 rate cuts in 2024. Kashkari also feels that 2 rate cuts would be the best case scenario, should rate cuts happen. That is not too certain at this point of time.
• The third scenario is that inflation remains unrelenting and the Fed is forced to hike the rates. That would go against the repeated assurances given by the Fed chair, Jerome Powell, that the rates had peaked in the US. A rate hike could have fairly disruptive effects on the colour of capital flows globally as well as in monetary policy divergence. He sees that as the least likely scenario, although it cannot be ruled out.
• The chief economist of Goldman Sachs has suggested that the ECB may cut rates several times in this year. In that case it remains to be seen what the US does. However, the experience in the past has been that the Fed normally sets the tone and other central banks wait for the Fed to give the signal. It is very unlikely that the ECB would take the initiative on its own to signal rate cuts, when the US is still talking about inflation.

The recent speech by Neil Kashkari has added a new dimension to the monetary policy debate since rate hikes were almost ruled out. Now Kashkari does not rule out that possibility. The only question is whether the US market really deserves so much of policy hawkishness, but for that we have to wait for more cues from the upcoming Fed meets.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MAY 03, 2024

The week to May 03, 2024 was marked by the Fed policy statement, which remained consistent that inflation would be the sole driver of rate action. The CME Fedwatch has already reduced its expectations to highly likely 1 rate cuts and a possible 2 rate cuts in the year 2024. The situation in 2025 is still too hazy at this point of time.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.4%	91.6%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.4%	32.5%	65.1%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	1.2%	17.4%	48.8%	32.6%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.5%	7.4%	29.3%	42.6%	20.2%
Dec-24	Nil	Nil	Nil	Nil	0.3%	4.4%	20.1%	37.0%	29.7%	8.5%
Jan-25	Nil	Nil	Nil	0.1%	2.1%	11.4%	27.6%	33.8%	20.3%	4.8%
Mar-25	Nil	Nil	0.1%	1.2%	7.0%	19.9%	30.8%	26.7%	12.1%	2.2%
Apr-25	Nil	Nil	0.5%	3.3%	11.8%	24.0%	29.3%	21.2%	8.4%	1.4%
Jun-25	Nil	0.2%	1.8%	7.4%	17.6%	26.5%	25.5%	15.1%	5.1%	0.7%
Jul-25	0.1%	0.8%	3.9%	11.1%	20.8%	26.1%	21.7%	11.5%	3.5%	0.5%

Data source: CME Fedwatch

There were 3 critical triggers in the previous week to May 03, 2024 with reference to CME Fedwatch.

• The big data point in the week was the Fed policy statement on May 01, 2024; which was followed by Jerome Powell’s interaction with the media. The Fed continued to remain non-committal about the timing of rate cuts; and also uncertain about rate cuts, per se. The only positive feature was that the Fed statement ruled out rate hikes; although there are still too many ifs and buts in the Fed statement to get a clear view.
• API crude inventories gave a positive surprise. After crude inventories fell -3.230 Million barrels in the previous week, it was expected to fall by another -1.500 Million barrels in the current week. However, the report by the API surprised on the positive side with a boost in inventories by +4.906 Million barrels. This managed to put down crude prices to $83/bbl and also the risk of oil inflation.
• The much awaited unemployment rate was announced for April 2024. The rate of unemployment rose by 10 bps from 3.8% to 3.9%. It should reduce the worries of the hawks as it shows the labour market getting back into a balance.

Let us turn to the key drivers of the CME Fedwatch for the latest week to May 10, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO MAY 10, 2024

The latest week to May 10, 2024 saw the CME Fedwatch continuing to presume just 2 rate cut in 2024; with rather volatile probabilities. After the speech by Neil Kashkari, hinting at a possible rate hike, the probabilities did shift to the right.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	3.5%	96.5%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.8%	24.6%	74.6%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	12.2%	48.6%	38.8%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.1%	4.5%	24.9%	45.2%	25.2%
Dec-24	Nil	Nil	Nil	Nil	0.1%	2.4%	14.9%	35.3%	35.0%	12.3%
Jan-25	Nil	Nil	Nil	Nil	1.0%	7.5%	23.3%	35.2%	25.7%	7.3%
Mar-25	Nil	Nil	Nil	0.5%	4.3%	15.5%	29.3%	30.4%	16.3%	3.6%
Apr-25	Nil	Nil	0.2%	1.9%	8.3%	20.4%	29.7%	25.4%	11.9%	2.3%
Jun-25	Nil	0.1%	1.0%	5.0%	14.2%	24.9%	27.6%	18.8%	7.2%	1.2%
Jul-25	Nil	0.4%	2.3%	8.0%	17.7%	25.8%	24.7%	15.0%	5.2%	0.8%

Data source: CME Fedwatch

There were 3 critical triggers in the week to May 10, 2024 with reference to CME Fedwatch.

• Neil Kashkari delivered a speech that elicited a lot of interested. In fact, Kashkari virtually ruled out rate cuts in 2024 and also went to the extent of suggesting that zero rate cuts was the most likely scenario. In the process, he also did not rule out rate hikes if inflation persisted and gave a best case scenario of 2 rate cuts at the most in 2024.
• API crude stocks showed a spike for the second week in a row. For the week, the oil inventories were expected to fall by -1.430 Million barrels, but amidst rising output, it ended up increasing the stocks by +0.509 Million barrels. That helped sober oil prices and the oil inflation risk once again during the week.
• The weekly forecast of the Atlanta GDP forecast for the second quarter ending June was raised by 90 bps from 3.30% to 4.20%. This is much better than what the markets had anticipated. While this shows that the hard landing is now finally out of the way, it also means that inflation may continue to remain sticky amidst higher growth and wages.

Let us finally turn to the major triggers for the CME Fedwatch in the coming week to May 17, 2024, in terms of key macro data announcements.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO MAY 17, 2024

There are 3 critical triggers to watch out for in the coming week to May 17, 2024 with reference to CME Fedwatch.

• The CPI inflation in the US will be out in the coming. As per Bloomberg estimates, the headline consumer inflation is likely to taper by 20 bps from 3.8% to 3.6% in April 2024. While that is positive, it is still a good 160 bps away from the eventual Fed target of 2% inflation. The fall in inflation is expected to be led by core inflation, while food and fuel inflation are expected to be steady to higher.
• Again, there are going to be some important Fed member speeches in the coming week. This includes speeches by Jefferson, Mester, Cook, Powell, Kashkari, and Bowman. Many of these members are known to lean more towards a hawkish stance. The market would be looking at how Jerome Powell builds a consensus for the markets to consume.
• As a trigger for inflation, the markets will be tracking the API weekly crude stocks and the IIP number for the week. The IIP is likely to be stable with over 78% capacity utilization, while the API stocks are likely to show positive accretion for third week in a row. That should be help to keep oil prices and oil inflation subdued in the week.

Let us finally turn to the outlook for interest rates in the year 2024 and what the CME Fedwatch is indicating about the direction and the timing of rate cuts; if any.

CME FEDWATCH PENCILS JUST TWO RATE CUTS IN 2024

There has been some interesting change in the latest week to May 17, 2024. As of the end of this week, the CME Fedwatch is pencilling in a 53% probability that the Fed would cut rates by 50 bps in year 2024. This is higher than just one rate cut pencilled two weeks back. The Fed is not expecting any rate cuts in June and July and the first rate cut looks likely only in the September meet. That would leave the Fed with just about enough time to implement 2 rate cuts in 2024; but even that would predicate on the fact that the inflation in the US showed credible signs of moving towards the 2% mark. Herea are key takeaways.

• What about the probabilities on the upside? After the GDP data and the PCE inflation data in the last week of April, there was a brief period when the CME Fedwatch anticipated a rate hike in 2024. However, that is off the table for now. While Neil Kashkari did hint at a possible rate hike to tackle sticky inflation, the CME Fedwatch is not yet factoring that in. It appears like the Fed rates have peaked at 5.25%-5.50%. Any move from here, would only trend lower, or remain flat.
• What about the downside consensus on the rate cuts side? The aggression and confidence that we saw after the policy statement is missing this week. The projection still stays at 2 rate cuts in 2024. However, the probabilities are now getting more open with the likes of Neil Kashkari hinting at the likelihood of rates moving in any of the three directions. Now, the CME Fedwatch is pencilling in one rate cut in September and one more rate cut in December 2024; but that would be subject to inflation showing its cooperation. In addition, the CME Fedwatch is also pencilling a third rate cut by April and the fourth rate cut by July 2025. However, one must take the 2025 probabilities with a pinch of salt as the clarity on the possibilities would only come after the Fed demonstrates some tangible action on the rates front in 2024.

For the time being the FOMC members are in wait and watch mode; and don’t want to risk cutting rates early. More so, since it may be hard to undo the inflation damage in such a case. The Fed has not changed its 3 rate cuts stance; but that is starting to increasingly like wishful thinking at this juncture. For now, sticky inflation is the only macro reality in the US!