Weekly Musings – CME Fedwatch change for week to August 09, 2024

12 Aug 2024 , 01:36 PM

IS THE US REALLY RUNNING THE RISK OF RECESSION?

In the last one week since the US labour data was announced, the big fear in the market has been the likelihood of a US economic slowdown. Most analysts are almost gloating, saying “See I told you so.” It was quite intriguing for many economists how the US had substantially tightened the rates and brought down inflation, without hurting growth. Now, that hurt may be starting to show. But is that really the case or was the July labour data just a flash in the pan. Here is what we took away from the debate on a likely US growth slowdown.

4. The rate of unemployment in July 2024 rose 20 bps from 4.1% to 4.3%. That is about 80 bps higher than last year. Remember, 3.5% is the unemployment rate that is described as full employment level in the US. But absolute numbers are much more incisive. The number of unemployed persons increased by 352,000 to 7.2 Million, compared to just 5.9 Million unemployed last year; a spike in the jobless numbers by 1.3 Million. But on the labour factor itself, there are more revealing data points. For example, while the number of permanent job losers was static, the temporary job losers increased by 249K to 1.10 Million. The number of part-time employed rose to 4.6 million in this period.
5. It is not just the job losses, but also the job seekers have gone up sharply. For instance, the number of people not in the labour force and currently wanting a job increased by 366,000 to 5.6 Million in July 2024. This is in sharp contrast to the decline in June 2024. One can argue that this data point could have made the unemployment number optically larger; and that is true to some extent. But the real problem is in the number of job additions, which clearly point to a likely slowdown or caution. Total non-farm payroll employment edged up by just 114,000 in July, as against average monthly accretion of nearly 215,000 jobs in the last twelve months.
6. Obviously, labour is just one part of the story, and we also need to look at the GDP growth numbers reported by the US Bureau of Economic Analysis (BEA) each month. Typically, there are 3 estimates of growth put out for each quarter; viz., advance estimate after a month, second estimate after 2 months and final estimate after 3 months. What does the latest data set tell us? It may be recollected that the first advance estimate for Q2-2024 US GDP growth came in at 2.8%. That is double the final GDP growth in Q1-2024 at 1.4%. However, we need to put the Q1 GDP growth in context. It was sharply lower on a sequential basis compared to 4.9% in Q3-2023 and 3.4% in Q4-2023. That was, perhaps, the first explicit signal that the hard landing which the Fed feared all along may be turning out to be prophetically true. However, you need 2 consecutive quarters of negative GDP contraction to be called a recession, and does not look too likely.
7. Finally, let us look at the yield spread indicator. A simple definition of inverted yield curve is if the 2 year bond yield is higher than the 10-year bond yield. This signals that investors expect future interest rates to decline as economic growth weakens. Currently, the US 2-year bond yields are at 3.84% while the 10-year bond yields are at 3.76%. This inversion has happened for the first time in 25 months, but such weakness should be sustained to be credible. Hence we will need more data points.

To cut a long story short, US recession indicators are still too patchy and unreliable. The final decision on whether or not it is a recession is taken by the Business Cycle Dating Committee of the National Bureau of Economic Research. It may be recalled that in 2022, the US saw an inverted yield curve and 2 quarters of negative GDP growth. However, NBER did not declare that officially as recession as the jobs data was very comfortable. For now, it is not the actual US recession but the expectations of a recession that are keeping global financial markets on tenterhooks. That scare is unlikely to go away in a hurry. But, one thing is that it is likely to make the rate cut almost inevitable for the US Fed in September.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED AUGUST 02, 2024

Let us start with a recap of the week to August 02, 2024; and how the CME Fedwatch panned out during the week. By the week to August 02, 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 two rate cuts would happen in 2024. Her are CME Fedwatch probabilities.

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 Fed monetary policy announced on July 31, 2024. The real signals were not in the Fed Monetary Policy statement, but in the interaction that Jerome Powell had with the media post the policy. He almost give an indication that the first rate cut would happen in September. However, Powell has cautioned the markets to expect more than one rate cut. However, CME Fedwatch had other ideas.
• API crude stocks continued to be the rather confusing factor in the week. In the previous week, the crude stocks had seen drawdowns of -3.741 Million barrels. In the week to August 02, 2024, the drawdown was expected at -1.600 Million barrels, but the actual negative figure was sharper at -3.436 Million barrels.
• 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. Initial jobless claims have risen sharply from 235K to 249K. Factory orders have also gone deeper into the negative. These are not conclusive data points, but suggestive of pressure on growth.

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

CUT TO PRESENT: CME FEDWATCH IN WEEK TO AUGUST 09, 2024

The latest week to August 09, 2024 saw the CME Fedwatch continue to factor in 3 rate cut in 2024, but also suggest 4 rate cut possibility this year. The lower than expected PCE inflation, Fed statement and growth concerns 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	48.5%	51.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	13.5%	49.3%	37.1%	Nil
Dec-24	Nil	Nil	Nil	Nil	3.9%	23.8%	45.8%	26.5%	Nil	Nil
Jan-25	Nil	Nil	Nil	3.8%	23.3%	45.3%	27.0%	0.7%	Nil	Nil
Mar-25	Nil	Nil	3.5%	22.1%	43.9%	28.1%	2.3%	Nil	Nil	Nil
Apr-25	Nil	2.3%	15.4%	36.1%	33.8%	11.6%	0.9%	Nil	Nil	Nil
Jun-25	1.4%	10.6%	28.6%	34.6%	19.7%	4.8%	0.3%	Nil	Nil	Nil
Jul-25	5.6%	17.5%	30.9%	28.9%	13.9%	3.0%	0.2%	Nil	Nil	Nil
Sep-25	14.5%	24.4%	29.8%	21.2%	8.3%	1.6%	0.1%	Nil	Nil	Nil

Data source: CME Fedwatch

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

• The labour data showed all round weakness and let to a sharp sell-off in global markets. It was not just a case of the unemployment rate for July 2024 rising to 4.3%, but also about more people looking for jobs, and the focus being more on temporary jobs than on permanent jobs.
• The drawdowns on crude oil inventories continued. After the shocker of -3.436 Million barrels in the previous week, this week it was supposed to taper to -1.600 Million barrels. However, the actual number came in at a deeper drawdown of -3.728 Million barrels. This could mean higher pressure on oil pressures and may support oil prices.
• Atlanta Fed GDP estimate for Q3 has come in sharply higher in the week. While the number was 2.5% in the previous week and the expectation for this week was also at 2.5%, the actual number came in at 2.9%. This raises the prospects of robust GDP growth in 2024 and may induce the Fed to go slow on rate cuts after September.

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.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO AUGUST 16, 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.

• Amidst the upcoming elections, the Federal budget deficit is likely to grow nearly 4-fold from $66 Billion to $254 Billion. This is likely to put pressure on the US inflation and also the value of the dollar in the global forex markets.
• The Bureau of Labor Statistics (BLS) is expected to announce the CPI inflation for July on Wednesday. For the month, it is expected to remain static at 3.0%, but the markets would be keen to know the implications for the PCE inflation, the Fed barometer.
• Initial jobless claims for the week are likely to go up from 233K to 235K. The labour data will be closely tracked for signs of slowdown in the US economy, as will be the spread between the 2-Year and 10-Year bond for signs of yield curve inversion.
• FOMC member, Dr Raphael Bostic is scheduled to be speaking this week. The markets are now looking at signals on whether the Fed will start off on a more aggressive note in September by cutting 50 bps instead of 25 bps. Fed speak will offer the hints.

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 – FED PRUDENCE VERSUS FEDWATCH OPTIMISM

With the clearest signal, till date, coming from Jerome Powell, the CME Fedwatch probabilities are showing a lot more optimism and assurance. With PCE inflation in control, and labour data indicating at first signs of a growth slowdown, the CME  Fedwatch is pencilling in much more aggressive rate cuts of 75 bps to 100 bps by the close of 2024. This is despite better Atlanta Fed GDP data and Jerome Powell cautioning markets not to expect more than 1 rate cut in 2024. Here are some key takeaways.

• 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 an increasing aggression built up now the hope that the Fed may look to aggressively front-end rate cuts in 2024 itself. The CME Fedwatch has assigned 48.5% probability for 50 bps rate cut in October, while there is a 49.3% probability that there could be 75 bps of rate cuts by the November 2024 meeting. In addition, the expectation by December 2024 is that there could be a 73.5% probability of 75 bps rate cut and a 54% probability of a 100 bps rate cut by December 2024. The probabilities just got a lot more aggressive after the US growth scare.
• What about the CME Fedwatch expectations stack for 2025? By April 2025, the CME Fedwatch is factoring in 87.5% probability of 150 bps of rate cuts, much higher than the probabilities in the previous week. In addition, the CME Fedwatch is also assigning a probability of 90% probability of 175 bps of rate cuts by September 2025 and a 69% probability of a 200 bps rate cut by September. This is a lot more aggressive than the original plan presented late in 2023 of 175 bps of rate cuts by December 2025. If the CME Fedwatch is to be believed, these rate cuts could happen much earlier.

For now, the Fed has given hint of one rate cut, nothing more. In fact, Powell has also cautioned not to expect anything more than that. In the past, several times the CME Fedwatch has diverged from the Fed statement, but it was the Fed that had ultimately prevailed. The Fed will go ahead and cut rates in September. However, any dovish aggressive beyond that is tough to second-guess at this point of time. The good news is that; the trajectory of rates from here is down; but eventually, it will still be the US Federal Reserve that will call the shots.