Weekly Musings – CME Fedwatch change for week to August 16, 2024

21 Aug 2024 , 09:17 AM

HOW THE TROIKA EFFECT WILL IMPACT THE RATES TRAJECTORY?

When the Fed meets in September, they will take a final call on whether to cut rates or not. The markets are quite positive about a September rate cut while the Fed is yet to be fully convinced. A lot will depend on how the data points pan out between now and the September Fed meet. The consumer inflation for July has come in 10 bps lower at 2.90% while the PCE inflation and the second estimate of Q3 GDP are expected in the last week of August. For now, it is touch and go. The CME Fedwatch looks overly enthusiastic but the FOME members, apparently do not share that optimism. While inflation will be one of the factors, there are also other factors that the Fed will consider. For instance, if inflation is falling but wages are still too high, then the inflation was bound to bounce back to higher levels. Similarly, if growth and consumption continued to be robust, low inflation would be tough to sustain. Michelle Bowman outlined her thoughts in a speech on how the Fed would be look at the three key variables, going into the September FOMC meet.

• The first variable to track is the GDP growth or the economic activity in the US in the first half of 2024. If you go by the data put out by the Bureau of Economic Analysis (BEA), the economic activity had moderated in the first half of 2024 after showing some real back-ended resilience in the second half of 2023. Just to compare; GDP growth had come in at 4.9% in Q3 and 3.4% in Q4 of 2023. According to Michelle Bowman, that kind of growth was not compatible with 2% inflation. However, in the first half of 2024, GDP growth went as low as 1.4% in Q1, although the second quarter first advance estimate has seen a bounce in GDP growth to 2.8%. That is why the August estimates will be crucial.
• Another factor that is likely to keep inflation at a higher trajectory is consumer spending. The Fed has initiated several measures to curb consumer spending and it appears to have worked. One key trend visible is that; consumers are pulling back on discretionary items and expenses, as evidenced in part by a decline in restaurant spending since late last year. However, sceptics argue that the slowdown in consumer spending may be due to normalization of loan delinquency rates. However, if rates are cut, then the same consumers may be induced to binge on consumption with borrowed money.
• The one factor that is supporting an early and aggressive rate cut is the labour market data. However, the concerns were visible only in the July data, so it is not too clear is the few swallows would really make a summer. The labour market continues to loosen, as the number of available workers has increased and the number of available jobs has declined. The July data has evidenced a sharp spike in unemployment as well as a fall in wage levels. In fact, July unemployment rate stood at 4.3% and has risen 100 bps in the last one year. The rate of joblessness is now a full 80 bps above what is officially called full employment at 3.5%. Wage growth is under 4% and that clearly makes an urgent case for rate cuts by the Fed.

HOW WILL THE FED READ THESE 3 DATA POINTS?

Michelle Bowman has underlined that there are not discrete answers to complex problems. Even if there is a rate cut in September, the Fed would still look at various scenarios while arriving at a future course of action. Fed has underlined that it would be solely guided by the incoming data flows. FOMC members like Bowman and Bostic believe that inflation is still elevated and the upside risks to inflation from the West Asian crisis cannot be ignored. The Fed is likely to focus predominantly on the price stability aspect while taking its final decision on rates. Bowman and Bostic have long held that restoring price stability is the key to long term real growth in the US. For now, they both feel that end of 2024 would be more appropriate time to embark on rate cuts in the US. If that means rate cuts have to wait, then the rate cuts will have to actually wait till the end of 2024. Either ways, even if the Fed does cut rates in September, the CME Fedwatch appears to be erring on the side of optimism.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED AUGUST 09, 2024

Let us start with a recap of the week to August 09, 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 2-3 rate cuts happening in 2024. Here 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

The week to August 09, 2024 had some interesting data points to look at.

• The labour data showed all round weakness and triggered a sharp sell-off in global markets. While the unemployment rate for July 2024 rose to 4.3%, the data also showed that there were more people looking for jobs, showing an excess of supply over demand. That has already had an impact in tempering wages.
• The drawdowns on crude oil inventories continued. After the shocker of -3.436 Million barrels in the previous week, the week to August 09, 2024 also disappointed. Against the expected drawdown of -1.600 Million barrels; the actual drawdown was much deeper at -3.728 Million barrels. That is likely to put more pressure on oil prices globally.
• Atlanta Fed GDP estimate for Q3 has come in sharply higher in the week in sync with the spike in Q2GDP estimates by the BEA. While the expectation for this week was at 2.5%, the actual GDP estimate for Q3 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 key triggers that influenced the CME Fedwatch during the latest week ended August 16, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO AUGUST 16, 2024

The latest week to August 16, 2024 saw the CME Fedwatch continue to factor in 3 rate cuts in 2024, but also suggested 4 rate cut possibility this year. Incidentally, the consumer inflation for July 2024 also came in 10 bps lower at 2.9%

Fed Meet	250-275	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	Nil	28.5%	71.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.3%	39.4%	53.3%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	2.2%	16.9%	43.6%	37.3%	Nil	Nil
Jan-25	Nil	Nil	Nil	Nil	2.2%	16.7%	43.2%	37.3%	0.6%	Nil	Nil
Mar-25	Nil	Nil	0.1%	.03%	18.3%	43.0%	35.0%	0.6%	Nil	Nil	Nil
Apr-25	Nil	0.1%	1.6%	10.9%	31.1%	39.1%	17.2%	0.1%	Nil	Nil	Nil
Jun-25	0.1%	1.2%	8.5%	25.9%	37.2%	22.8%	4.4%	Nil	Nil	Nil	Nil
Jul-25	0.5%	4.3%	15.8%	30.7%	31.2%	15.0%	2.5%	Nil	Nil	Nil	Nil
Sep-25	3.7%	12.9%	27.0%	31.1%	19.0%	5.6%	0.6%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

Here are some of the key triggers that had an impact on the CME Fedwatch probabilities during the current week to August 16, 2024.

• Amidst the upcoming elections, the Federal budget deficit actually grew by nearly 4-fold from $66 Billion to $244 Billion. It was supposed to touch $254.3 Billion, but this is small consolation. It will put pressure on US inflation and also the value of the dollar.
• The CPI inflation came in 10 bps lower at 2.9% for the month of July. While the trend is on target, the Fed is still concerned that the current level of consumer inflation is a good 90 bps away from the target. Fed will now await the PCE inflation data.
• Initial jobless claims for the week were supposed to go up from 234K to 236K. However, that final data came in at 227K, which shows less stress on labour data. The Fed will now await the August unemployment numbers before taking a call on rates.
• There was some respite on oil inventories. After a drawdown of -3.728 Million barrels last week, the week was expected to see a drawdown of -1.900 Million barrels. However, the final number came in positive as accretion of 1.357 Million barrels.

Let us now turn to some of the key triggers for the CME Fedwatch in the coming week to August 23, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO AUGUST 23, 2024

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

• The Fed minutes of the July 31 meeting are expected to be published in the coming week. The minutes feature detailed discussion on the rates trajectory among the members and gives a lucid idea of what the FOMC is thinking.
• The big news will be the Jackson Hole Symposium of central bankers in the US. While the market will await the speech by Jerome Powell on monetary easing, the markets would also be keen to hear what the BOJ governor has to say on their hawkish outlook.
• Several big voices from the Fed like Raphael Bostic, Christopher Waller and vice chair Michael Barr will be speaking in the coming week. The markets will be tracking their wordings closely for clues on the trajectory of rates.
• Once again the initial jobless claims will be in focus. Last week, the jobless claims came in lower than expected at 227K. However, this week it is expected to bounce back to a higher level of 233K. That will surely have a bearing on the decision of the Fed to tweak benchmark rates in the upcoming September Fed meeting.

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 – IS THE CEM FEDWATCH OPTIMISM FOR REAL?

The one question that comes to mind is whether the optimism of the CME Fedwatch is for real. It is true that inflation has fallen and the labour data is showing signs of stress. However, the data is not such that would justify such aggressive rate cuts as the CME Fedwatch is pencilling. The Fed members like Raphael Bostic and Michelle Bowman have even ruled out any rate cuts in September and have hinted at the first rate cut only coming in by December. Clearly, the dichotomy between what the Fed is saying, what the data is showing and what the CME Fedwatch is indicating is far apart from each other. How these will get reconciled is something only time will tell. Here are some key takeaways.

• With rate hikes totally 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 increasing evidence aggression building up. The CME Fedwatch expectation is expecting big rate cuts by end of 2024 itself. The CME Fedwatch has assigned 100% probability for 50 bps rate cut in November, while there is a 46.7% probability that there could be 75 bps of rate cuts by November 2024 itself. In addition, the expectation by December 2024 is a 100% probability of 75 bps rate cut and a 62.7% probability of a 100 bps rate cut by December 2024. It has grown more aggressive than the previous week, and starting to look unrealistic now.
• What about the CME Fedwatch expectations for 2025? By April 2025, the CME Fedwatch is factoring in 83% probability of 150 bps of rate cuts. In addition, the CME Fedwatch is also assigning a probability of 94% probability of 175 bps of rate cuts by September 2025 and a 74% probability of a 200 bps rate cut by September. This is much quicker than the most aggressive long term estimates put out by the Federal Reserve.

At the end of the day, it will depend on how the FOMC members see it. Fed has hinted at 1 rate cut in 2024; and even here there is a dichotomy. While Powell hinted at a rate cut in September 2024, the hawks like Bostic and Bowman are more inclined towards cutting rates closer to the end of 2024. For now, it is hard to second guess what the Fed has in mind. Clearly, it nothing as aggressive as the CME Fedwatch wants it to be.