Weekly Musings – CME Fedwatch change for week to December 08, 2023

11 Dec 2023 , 07:25 AM

US MARKETS AWAIT BIG CUES IN THE COMING WEEK

During the current week, the divergence between the CME Fedwatch and the Fed stance continued. However, the extent of the divergence sobered in the current week. The CME Fedwatch still expects aggressive rate cuts, but it is now keeping the option of one more rate hike still open. But the first of the big events in the coming week will be the consumer inflation data on December 12, 2023. The CPI inflation in October 2023 had come in lower at 3.2%, but the Fed has been worried that the level of consumer inflation is still about 120 bps away from the avowed inflation target of the Federal Reserve at 2%. That opens the doors for at least one more rate hike of 25 bps in future policies. While the Fed still relies on PCE inflation, it is the CPI inflation that sets the tone for PCE inflation. 

The other big event in the coming week is the last Fed policy statement of the year to be put out on December 13, 2023. The consensus on the street is that the Fed will hold status quo since it has committed itself to holding the rates at a higher level for a longer period of time. There are expectations that the CPI inflation could move towards 3% or even lower and that would be a huge positive for market sentiments. In the last few months, the US has seen a sharp fall in food inflation, fuel inflation as well as core inflation. For now, it looks like the Fed may just about maintain status quo on rates. However, that would largely depend on the inflation outlook that the Fed puts out for the next few months.

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 08, 2023 was relatively sober, after the US GDP data and the US PCE inflation data; and before the Fed policy statement. During the week, the US 10-year benchmark bond yields moved lower from 4.259% to 4.229%, despite the spike on Friday. Yields have now fallen from a high of 5%.  What about the dollar index, a barometer of dollar strength against a basket of global hard currencies. The dollar index (DXY) gained marginally to 104.01 levels, compared to 103.71 levels at the start of the week. Both these variables normally have a strong influence on the direction of the CME Fedwatch. 

RECAP – CME  FEDWATCH FOR THE WEEK ENDED DECEMBER 01, 2023

The previous week to December 01, 2023 saw CME Fedwatch undergo a complete shift all over again. Dovishness was back in the CME Fedwatch in a big way, even at the cost of a sharp divergence from the Fed’s stated point of view. It was the week when the US Q3 GDP came in sharply higher than expected while the PCE inflation came in sharply lower than expected. It looked like happier times with inflation receding and hard landing out of the way. That led the CME Fedwatch to take a bold stance in favour of dovishness.

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 week to December 01, 2023. They only helped to widen the divergence of CME Fedwatch from the Fed stance.

• The second estimate of Q3 GDP in the US was announced during the week and it was a positive surprise. GDP growth got upgraded from 4.9% in the first advance estimate to 5.2% for Q3 in the second estimate. That meant two things. Firstly, it almost rules out any fears of hard landing for the US economy now. Secondly, it also means that the eventual full year GDP for the US could be better than anticipated.

   

• Another important data-point this week was the PCE inflation (personal consumption expenditure) inflation; which is based on consumer spending. The Fed actually relies more on PCE inflation than on CPI inflation for its policy action. The PCE inflation fell by 40 bps month-on-month from 3.4% to 3.0% for the month of October 2023. This is a signal that the Fed has the luxury of keeping rates on hold, and not worrying about rate hikes, at least in the near future.

   

• During the week, Fed chair, Jerome Powell and Michelle Bowman spoke on the nuances of the Fed stance. Both have generally veered towards a hawkish point of view and both have warned that the rate hikes were far from done. In fact, they also warned the markets not to get carried away by the unbridled enthusiasm about dovishness; in an obvious reference to the exuberance shown by the CME Fedwatch in the latest week.

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, although the CME Fedwatch is taking much more dovish bets on the market.

CME FEDWATCH IN THE LATEST WEEK TO DECEMBER 08, 2023

The latest week to December 08, 2023 saw CME Fedwatch maintain its divergence from the Fed point of view. However, the divergence has showed signs of sobering, probably realizing that the CME Fedwatch may have overstretched in its dovish imagination in the previous week. Eventually, it remains to be seen if the Fed stance prevails or whether the CME Fedwatch looks rather visionary. Clearly, the Fed is not likely to let its guard down, especially when it comes to inflation. It looks like the Fed and the CME Fedwatch on rates on the upside, with the dichotomy more on the direction and pace of rate cuts.

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	97.1%	2.9%
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	4.0%	93.2%	2.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	1.8%	43.2%	53.4%	1.6%
May-24	Nil	Nil	Nil	Nil	1.0%	26.4%	49.3%	22.6%	0.6%
Jun-24	Nil	Nil	Nil	0.7%	18.9%	42.5%	30.5%	7.1%	0.2%
Jul-24	Nil	Nil	0.5%	13.1%	35.0%	34.3%	14.6%	2.4%	0.1%
Sep-24	Nil	0.4%	9.3%	28.4%	34.5%	20.5%	6.1%	0.8%	Nil
Nov-24	0.2%	5.5%	20.2%	31.9%	26.5%	12.3%	3.0%	0.3%	Nil
Dec-24	4.2%	16.2%	28.8%	28.0%	16.1%	5.5%	1.1%	0.1%	Nil

Data source: CME Fedwatch

In the absence of big data flows, there were still some key triggers in the week to December 08, 2023 with reference to CME Fedwatch.

• On Monday, the factory orders for October were announced. It had grown at 2.3% in the previous month. In October, the markets were expecting contraction of -2.8%, but the actual contraction of factory orders was deeper at -3.6%, putting limits on growth.

   

• Crude oil inventories had stabilized to 1.61 million barrels in the previous week. In the recent week, the crude inventories were expected to fall by -1.35 million barrels, but actually fell by -4.63 million barrels, a fact that is likely to push oil prices higher.

   

• The trade balance for October did not spring any surprise. The trade deficit was expected to be at $64.20 billion and it was close at $64.30 billion. While imports were flat MOM, the exports actually tapered lower for October 2023.

   

• The Atlanta Fed GDP estimates for the fourth quarter are likely to come in at around 1.3%, but the actual estimate by the Atlanta Fed came in slightly lower at 1.2%. That is indicative of some pressure on Q4 growth in the US, but we need to wait and watch.

   

• Finally, the Fed announcement of balance sheet status was also a key data point. In the last 17 months, the Fed has unwound its bond book by $1.3 trillion from $9.1 trillion to $7.8 trillion. This week, the Fed bond book was further wound down to $7.73 trillion.

The broad drift of the data for thew week was that Q4 GDP growth could be lower than expected while the inflation in Q4 could be slightly higher than expected.

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO DECEMBER 15, 2023

There are 3 critical triggers to watch out for in the coming week to December 15, 2023 with reference to CME Fedwatch.

• On Tuesday, the CPI inflation for November is likely to be announced. It is likely to come down marginally from 3.2% to 3.1% as per the Bloomberg estimates, although the street estimates that based on the movement of crude and food prices, the inflation could even dip below the 3% mark. In fact, the 3% mark will be the important cut-off point for the CPI inflation. Anything lower than 3% will be distinctly positive.

   

• The last Fed policy of 2023 will also be announced on Wednesday, December 13, 2023. The broad consensus is that the Fed has no incentive to hike the rates and so it is likely to stay at the range of 5.25% to 5.50%. However, more than the rate action, it will be the language of the Fed and the conviction of Jerome Powell that will count for a lot more.

   

• In the aftermath of the monetary policy statement, the FOMC (Federal Open Markets Committed) will also release critical data on long term projections. It will put out the interest rate projections and inflation projections at the end of 1 year, 2 years and 3 years and will also put out for the sustainable long term. In these projections, the outlook for long term rates and inflation will hold the key to future rate action by the US Federal Reserve. It assumes a lot more importance in this month.

For now, all eyes will be on the last and final Fed meet of this year on December 13, 2023. Combined with the consumer inflation, we could see the tone for rates being set.

CME FEDWATCH VS FED STANCE: DICHOTOMY CHANGED AGAIN

To be fair, it was a week of volatile change in the CME Fedwatch. The divergence is still there but with some changes. The CME Fedwatch, probably, realizes of diverging from the Fed statement by a large margin and for too long. Here is the gist of the divergence.

• On the upside, there appears to be a better consensus. Last time, the CME Fedwatch had almost concluded that rate hikes were down and dusted. This time around, the CME Fedwatch has kept a small window open on the upside, should push come to shove.

   

• What about terminal rates? The Fed has indicated the likelihood of 2 more rate hikes taking the terminal rates to 6%. For now, the focus of the Fed will be Higher for Longer. However, CME Fedwatch is giving another 25 bps upside, in a worst case scenario.

   

• The real 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 bordering less on audacity pegging rate cuts to the tune of 125 bps to 150 bps by the end of the year 2024. That is still aggressive.

Eventually, 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,” and for now neither side appears to be obliging.