Weekly Musings – CME Fedwatch change for week to August 02, 2024

4 Aug 2024 , 09:44 PM

FED STATEMENT CAUTIOUSLY OPTIMISTIC ON RATE CUTS

The Fed meeting concluded on July 31, 2024 and the Fed statement made it clear that the Fed members would like to see more traction on inflation falling, before committing to rate cuts. However, the post policy conference by Jerome Powell was a classic giveaway as we almost admitted that the next rate cut would be in September 2024. That is what, even the CME Fedwatch was pencilling. Here are some signals we took away from the Fed statement on July 31, 2024.

• You can almost call it a tone shift, as Jerome Powell clearly suggested that inflation was getting closer to its 2% target. This was, probably, the most significant signal that the Fed would cut rates by 25 bps on September 18, 2024, when it gathers for its next FOMC meeting. However, the Fed statement, barring Jerome Powell’s dovish overtones, remained cautious that more traction on inflation would be needed before rate cuts.
• More importantly, the Fed statement also hinted that risks to achieving its employment and inflation goals continue to move into better balance. The Fed has always tried to maintain a balance between price stability and unemployment and that was becoming easier with the unemployment rate moving higher towards 4.1%. This was a slightly dovish upgrade to the language of the Fed.
• However, on a more circumspect note, the Fed chair Jerome Powell underlined that there was no decision made about actions at future meetings and that the Fed would take each meeting on its merits and be data driven. Powell did hint that if there were no surprises in data, then a rate cut in September was on the cards.
• In terms of language, the Fed statement was an upgrade on two fronts. Firstly, the statement used “adequate progress” instead of “modest progress” last time to describe taming inflation. Secondly, the previous statement, had characterized inflation as being elevated, while the July 31 meeting classified inflation as just “somewhat elevated.”
• Any rate cut decision was bound to raise questions on prudence. Fed has pre-emptively answered the question, stating that rates were at the highest level in last 23 years. After 11 consecutive rate hikes, Fed kept status quo for one year. In short, the message was that; the Fed had been adequately attentive to risks prior to embarking on rate cuts.
• On the subject of the pressure created on business borrowing costs by higher interest rates, the Fed has maintained that the central bank would continue to be guided by the twin goals of price stability and employment. Other factors would be just supportive in nature and would not be the criterion for a rate cut, going ahead.
• There are positive and supportive trends in labour data. Unemployment rate has gone up sharply from 3.5% to 4.1%, while wages are increasing at their slowest pace in 3 years. In addition, the recent bounce in GDP in Q2-2024 from 1.4% to 2.8% is testimony to the fact that the risk of hard landing are not an issue any longer!

What is the gist of the Fed story? A rate cut looks highly probable  in September. Powell has also cautioned against being too optimistic as indicated by the CME Fedwatch. Fed officials will proceed carefully, despite signs of inflation weakening. We will, most likely, see the first rate cut in September, but beyond that, the trajectory is not all that clear.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JULY 26, 2024

Let us start with a recap of the week to July 26, 2024; and how the CME Fedwatch panned out during the week. By the week to July 26, 2024, the markets had more or less crystallized that the first rate cut would happen by September 2024 and also assigned a high probability to dual rate cuts by the end of 2024. Her are the CME Fedwatch probabilities.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	93.8%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	11.5%	88.2%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	0.2%	7.5%	60.5%	31.8%	Nil
Dec-24	Nil	Nil	Nil	Nil	0.2%	7.0%	56.9%	33.8%	2.1%	Nil
Jan-25	Nil	Nil	Nil	0.2%	5.0%	42.3%	40.5%	11.4%	0.6%	Nil
Mar-25	Nil	Nil	0.1%	4.1%	35.6%	40.8%	16.6%	2.6%	0.1%	Nil
Apr-25	Nil	0.1%	2.4%	22.4%	38.7%	26.8%	8.5%	1.1%	Nil	Nil
Jun-25	0.1%	1.7%	15.9%	33.3%	30.7%	14.5%	3.5%	0.4%	Nil	Nil
Jul-25	0.7%	7.7%	23.3%	32.2%	23.7%	9.8%	2.2%	0.2%	Nil	Nil
Sep-25	7.3%	21.1%	30.9%	25.0%	11.8%	3.3%	0.5%	Nil	Nil	Nil

Data source: CME Fedwatch

For the week to July 26, 2024, the important triggers were the first advance estimates of Q2 GDP and the PCE inflation data announced towards the end of the week.

• Once again, it was the drawdown in API crude inventories that gathered all the attention. It remains a key factor in driving fuel inflation; and therefore, overall inflation. For the week, the API crude stocks were expected to see drawdowns of -2.470 Million barrels, compared to accretion 4.440 Million barrels in the previous week. However, the week saw drawdowns at -3,900 Million barrels; much higher than street estimates. Despite higher drawdowns, the crude prices actually eased during the week. The reasons were the anticipated ceasefire in West Asia and the weak Chinese economy keeping Chinese demand for oil under pressure.
• In big data flows, the first advance estimate of Q2GDP was put out by the US Bureau of Economic Analysis (BEA) on July 25, 2024. The Q2 advance estimate of GDP growth came in sharply higher at 2.8%, as compared to the final Q1 GDP figure of 1.4%. While this shows robustness in growth, the GDP growth is still lower than 4.9% and 3.4% reported in the third and fourth quarters of 2023 respectively.
• The PCE (personal consumption expenditure) inflation was published by the US BEA on Friday July 26, 2024. PCE inflation tapered 10 bps from 2.6% to 2.5% during the week, in tandem with the CPI inflation dipping 30 bps. The lower PCE inflation in June 2024, makes a strong base case for rate cuts in September 2024. The lower PCE inflation in June 2024 was led by a fall in energy inflation.

Let us now turn to the key events that shaped the CME Fedwatch in the week to August 02, 2024, and how it actually shaped the probabilities.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO AUGUST 02, 2024

The latest week to August 02, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024, but also suggest 3 rate cuts this year. The lower than expected PCE inflation and the Fed statement have made the CME Fedwatch a lot more dovish.

Fed Meet	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	22.0%	78.0%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	21.0%	75.3%	3.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	2.6%	27.7%	66.4%	3.3%	Nil
Jan-25	Nil	Nil	Nil	Nil	2.2%	24.3%	61.2%	11.9%	0.4%	Nil
Mar-25	Nil	Nil	Nil	2.2%	23.8%	60.3%	13.0%	0.7%	Nil	Nil
Apr-25	Nil	Nil	1.5%	17.4%	49.5%	27.0%	4.4%	0.2%	Nil	Nil
Jun-25	Nil	1.1%	13.1%	40.8%	33.1%	10.5%	1.3%	0.1%	Nil	Nil
Jul-25	0.5%	6.5%	25.6%	37.3%	22.9%	6.4%	0.8%	Nil	Nil	Nil
Sep-25	6.0%	22.8%	35.7%	25.0%	8.7%	1.6%	0.1%	Nil	Nil	Nil

Data source: CME Fedwatch

Needless to say, the big trigger in the week was the Fed monetary policy statement, which clearly veered towards the first rate cut in September 2024.

• The big event in the week was the July monetary policy of the Fed announced on July 31, 2024. There were some very ambivalent signals that came from the policy statement. However, the press interaction by Jerome Powell after the Fed statement seemed to clearly hint at the first rate cut happening in September. However, Powell has been quick to caution that markets should not expect more than one rate cut in this year and the Fed may look to compensate in 2025. The CME Fedwatch was, however, a lot more optimistic as it is pencilling in 2 to 3 rate cuts in 2024 itself.
• API crude stocks continued to be the vexing factor in the week. In the previous week, the crude stocks saw drawdowns of -3.741 Million barrels. This week, the drawdown was expected at -1.600 Million barrels, but the actual figure was sharper at -3.436 Million barrels. However, amidst China slowdown fears, this had little impact.
• One area of concern could be that the jobs data may be showing signs of stress in the economy. If you look at the week to August 02, 2024, there are several indicators. Job openings (JOLTS) are lower than last week and also lower than estimates. Initial jobless claims have risen sharply from 235K to 249K this week. Factory orders have also gone deeper into the negative. These are not conclusive data points, but surely suggestive.

Let us now turn to the key triggers for the CME Fedwatch in the coming week to August 09, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO AUGUST 09, 2024

The next week has limited data flows, so it would be more about the micro issues on the macroeconomic front. There are 4 key points to look out for.

• The API crude stocks will be again in focus, In the last two weeks, the drawdowns have been more than anticipated. Ideally, this should have put pressure on the crude oil prices, but the slowdown in China led to lower oil prices. However, the API crude inventory drawdowns will be a key point to watch.
• After the sharp spike in initial jobless claims from 235K to 249K in the current week, the next week assumes importance. This data will have to be correlated with the GDP data and factory orders data to see if it is impacting the growth trajectory of the US economy.
• The previous week saw a sharp fall in the US bond yields and in the US dollar index on the back of dovish signals coming from the Fed. This week, the CME Fedwatch will be closely tracking these two data points for direction on which way rates are headed.
• FOMC member, Mary Daly is scheduled to speak next week. Daly normally drops subtle clues about the rate trajectory, but she is also a hawk. Hence, her talk will get a lot attention from investors and analysts.

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.

CME FEDWATCH – TWO RATE CUTS IN 2024 OR THREE?

With the clearest signal, till date, coming from Jerome Powell, the CME Fedwatch probabilities are showing a lot more optimism and assurance in a narrow range. With PCE inflation in control, labour data in balance and Fed also inclined, it looks like September rate cut will happen. CME Fedwatch is pencilling in 2 to 3 rate cuts in 2024, despite Jerome Powell cautioning markets not to expect more than one rate cut in 2024.

• With rate hikes 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 some more aggression built up between November and December meets. The CME Fedwatch has assigned 96.3% probability to the second rate cut in November. In addition, there is a 96.7% probability that the third rate cut will happen by December. Effectively, we are looking at 3 confident rate cuts in 2024.
• What about the CME Fedwatch expectations stack for 2025? By April 2025, the CME Fedwatch is factoring in 95.4% probability of 125 bps of rate cuts, much higher than the probabilities in the previous week. In addition, the CME Fedwatch is also assigning a probability of 89.6% probability of 175 bps of rate cuts by September 2025. The original plan presented late in 2023 was of 175 bps of rate cuts by December 2025 and now the CME Fedwatch expects that would be bettered.

For now, the Fed has given hint of one rate cut, nothing more. Anything beyond that is CME Fedwatch optimism; which is something that has been awfully off the mark in the past. The Fed will go ahead and cut rates in September. However, it may prefer to err on the side of caution and take up further rate cuts only in 2025. One thing is clear; that the trajectory of rates from here is down; but it will not be as aggressive as the CME Fedwatch suggests!