Weekly Musings – CME Fedwatch change for week to December 01, 2023

3 Dec 2023 , 09:35 AM

US GDP AND PCE INFLATION FAVOUR END OF RATE HIKES 

In the previous 4 weeks since the Fed policy statement, the indications coming from the US Fed statement and the CME Fedwatch were at loggerheads of differing intensity. In the first week of November, the Fed statement status quo on rates was seen as a signal that rate hikes were done. This led the CME Fedwatch to turn dovish. The hawkish statement of Fed members threw cold water in the second week as the CME Fedwatch appeared to converge with the Fed stance. In next 2 weeks, the love-hate relationship continued as the fall in bond yields favoured the CME Fedwatch stance while Fed minutes favoured the Fed stance. Let us turn to latest week to December 01, 2023. What were the signals from the CME Fedwatch.

It was again a week of sharp divergence between the CME Fedwatch and Fed stance with enough justifications for the dichotomy. The US GDP growth at 5.2% in Q3 means that the idea of hard landing is out and that Fed has little incentive to hike rates and curb growth when 20 months of rate hikes achieved little. The second big data point was PCE inflation; which that Fed uses for rate setting. The PCE inflation fell 40 bps to 3.0%. That can be interpreted as a sure shot journey towards the eventual target of 2% and there is little that the Fed can now do to justify rate hikes. Not surprisingly, the dichotomy increased in the current week with the CME Fedwatch betting that rates would be cut as much as 150 to 175 bps by end of 2024, even as Fed is unwilling to commit above 50 bps.

HOW US BOND YIELDS AND DOLLAR INDEX (DXY) MOVED THIS WEEK

The US 10 year bond yields and the dollar index had been on a see-saw in last 3 weeks. The latest week to December 01, 2023 was relatively sober, after the US GDP data and the US PCE inflation data were announced. During the week, the US 10-year benchmark bond yields moved lower from 4.390% to 4.209%. Yields have now fallen a full 79 bps in the last 4 weeks from a high of 5% to 4.21%.  What about the dollar index, a barometer of dollar strength against a basket of global hard currencies. The dollar index (DXY) was once again relatively flat at 103.27 levels, compared to 103.20 levels at the start of the week. Both these variables normally have a strong influence on CME Fedwatch, in deciding the direction. 

RECAP – CME  FEDWATCH FOR THE WEEK ENDED NOVEMBER 24, 2023

The previous week to November 24, 2023 saw CME Fedwatch seesaw continue as it once again diverged from the Fed point of view. It was the week when the Fed minutes were announced and that pushed the CME Fedwatch to converge with the Fed stance on the upside, if not on the downside. The Fed minutes were rather esoteric in the sense that it focused more on the fact that there was no discussion about rate cuts. That spooked the CME Fedwatch and pushed it closer to the Fed stance.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	95.5%	4.5%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	87.6%	12.0%	0.4%
Mar-24	Nil	Nil	Nil	Nil	Nil	21.0%	69.5%	9.2%	0.3%
May-24	Nil	Nil	Nil	Nil	8.1%	39.7%	46.3%	5.8%	0.2%
Jun-24	Nil	Nil	Nil	4.0%	23.8%	43.0%	26.1%	3.0%	0.1%
Jul-24	Nil	Nil	2.2%	14.7%	34.1%	33.9%	13.3%	1.4%	Nil
Sep-24	Nil	1.3%	9.7%	26.3%	34.0%	21.8%	6.3%	0.6%	Nil
Nov-24	0.7%	5.7%	18.4%	30.4%	27.6%	13.6%	3.3%	0.3%	Nil
Dec-24	4.7	14.5%	26.7%	28.4%	17.9%	6.5%	1.2%	0.1%	Nil

Data source: CME Fedwatch

For the week to November 24, 2023, there were 3 main factors that had impacted the return of convergence between the CME Fedwatch and the Fed stance.

• The first big data point in the US in the week to November 24, 2023 was the detailed publication of the FOMC (Federal Open Markets Committee) minutes. As is the practice, the Fed announced the minutes 21 days after the Fed meet, which had commenced on October 30, 2023. The Fed statement was more hawkish than originally expected and the Fed also clarified that rate cuts were not even being discussed. On the subject of rate hikes, Fed maintained its stance that rate hikes were not done and dusted. However, on the downside the Fed has stuck to its view of just 2 rate cuts of 25 bps each by the end of year 2024. That led to a greater convergence of CME Fedwatch with Fed.

   

• The big factor in the week was the sharp spike in the API crude oil stocks in the US, a barometer of whether the odds were stacked in favour of supply or demand. Against market expectation of 1.47 million barrels of crude, the actual API inventories turned in at 9.05 million barrels of crude. This was a dampener for oil prices which fell to $80/bbl. However, that reduced the expectations on the inflation front, ruling out rate hikes.

   

• Another important data-point was the preliminary release of the Atlanta Fed GDP–Q4 estimate during the week. That was pegged at 2.1%, but with third quarter GDP being upgraded higher from 4.9% to 5.2%, this could only improve in the coming months. Clearly, it looks like the Fed has reasons to maintain status quo on rates and, considering the robust GDP data, even consider rate hikes at a later date. For now, the Fed status quo is just to ensure they have enough fire power available with them in the event of higher growth and consumption spending again pushing inflation higher.

The broad message from the Fed is that it is not done with rate hikes and rate cuts will not be discussed. However, that has not impacted the unbridled optimism of CME Fedwatch.

CME FEDWATCH IN THE LATEST WEEK TO DECEMBER 01, 2023

The latest week to December 01, 2023 saw CME Fedwatch once again diverge from the Fed point of view. Jerome Powell may have stayed hawkish in is language, but the CME Fedwatch was busy charting its own dovish path of multiple rate cuts in 2024. Whether that happens and with such intensity, remains to be seen. After all, the Fed is known to take its communication rather seriously. Here is the story from probability chart of CME Fedwatch.

Fed Meet	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	97.3%	2.7%
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	16.1%	81.7%	2.2%
Mar-24	Nil	Nil	Nil	Nil	Nil	10.0%	56.8%	32.4%	0.8%
May-24	Nil	Nil	Nil	Nil	7.4%	44.5%	38.8%	9.1%	0.2%
Jun-24	Nil	Nil	Nil	6.3%	39.2%	39.6%	13.4%	1.5%	Nil
Jul-24	Nil	Nil	5.1%	32.8%	39.5%	18.5%	3.8%	0.3%	Nil
Sep-24	Nil	4.2%	28.1%	38.4%	22.1%	6.3%	0.9%	0.1%	Nil
Nov-24	2.5%	18.2%	33.9%	28.7%	13.0%	3.2%	0.4%	Nil	Nil
Dec-24	15.9%	29.8%	30.0%	17.1%	5.8%	1.2%	0.1%	Nil	Nil

Data source: CME Fedwatch

There were 3 major triggers impacting the CME Fedwatch in the current week. All of them only helped to propel the CME Fedwatch to diverge from the Fed stance. 

• The second estimate of Q3 GDP in the US was out this week and it was a pleasant surprise. GDP growth got upgraded to 5.2% for Q3; 30 bps higher than the first estimate at 4.9%. It means that the eventual US GDP could get upgrade from current levels and that is a positive signal of business as usual. While the Fed will use that as a cushion, the CME Fedwatch feels that robust GDP would be used to cut rates.

   

• Another important data-point this week was the PCE inflation. Now, the PCE inflation (personal consumption expenditure) inflation is based on consumer spending and is considered the key ratio by the Fed for its rates stance. The PCE inflation is expected to fall from 3.4%, but the 40 bps fall was more than expected. CME Fedwatch is interpreting the sharp fall as a sign that rate hikes must transform into rate cuts. 

   

• During the week, Fed chair, Jerome Powell spoke on the nuances of the Fed stance. One challenge that Powell now has is to explain the disconnect between the Fed’s hawkishness and the long term direction of interest rates. It remains to be seen if “Higher for Longer” is acceptable to the markets as a macro narrative. Markets were expecting clarity on divergence, but Powell has chosen to stay hawkish.

On the CME Fedwatch front, the big story for the week was the PCE inflation, GDP estimates and the persistent divergence of the CME Fedwatch from the Fed stance. For now, the Fed is clearly on wait-and-watch mode.

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO DECEMBER 08, 2023

There are 5 major triggers to watch out for in the coming week to December 01, 2023 with reference to CME Fedwatch.

• On Monday, the factory orders for October are expected to be announced. It had grown at 2.8% in the previous month and this is a signal that the uptick in GDP in the third quarter is not just a flash in the pan, but a deeper signal of growth reviving.

   

• Crude oil inventories had stabilized to 1.61 million barrels in the latest week and the coming week would be critical in the aftermath of the OPEC meeting. It remains to be seen if the US inventory action is in sync with the OPEC action on supplies.

   

• The trade balance for October with the import and export of US trade and services are expected to be announce this week. It remains to be seen if the deficit narrows, as is likely, since that would mean more strength for the dollar index.

   

• The Atlanta Fed GDP estimates for the fourth quarter are likely to be again upgrade higher from 2.1% after the healthy show by Q3 GDP. A recovery in growth in goods and services is likely to boost GDP in Q4.

   

• Finally, the Fed announcement of balance sheet status will also be watched. In the last 17 months, the Fed has unwound its bond book by $1.3 trillion from $9.05 trillion to $7.75 trillion. That is likely to do the job of rate hikes partially.

For now, all eyes will be on the last and final Fed meet of this year in the middle of December, which could set the tone for the coming year.

 

CME FEDWATCH VS FED STANCE: DICHOTOMY ALL OVER AGAIN

In the last few weeks, there has have been weekly change in the extent of dichotomy between the CME Fedwatch and the Federal Reserve stance. It is still not clear, what is more reliable but some broad trends are emerging and both stands are justified.

• On the upside, there appears to be little consensus. The probability of even a 25 bps rate hike has almost gone down to insignificant levels. That is rather surprising at a time when the US inflation is still about 100 bps away from the target. 

   

• What about terminal rates? The Fed has indicated the likelihood of 2 more rate hikes taking the terminal rates to 6%. But the focus of the Fed will be Higher for Longer. However, CME Fedwatch has already called 5.50% the peak rate for the US.

   

• The big gap is on the downside. While the Fed has still stuck to just 50 bps rate cut by end of 2024, the CME Fedwatch is now almost bordering on audacity pegging rate cuts to the tune of 150 bps to 175 bps by the end of the year 2024.

At the end of the day, it will depend on how the Fed interprets the data. However, this time, convergence may not be easy. It will be more a game of “Who Blinks First.”