Weekly Musings – CME Fedwatch change for week to December 15, 2023

17 Dec 2023 , 01:13 PM

US FED FINALLY SAYS GOOD BYE TO HAWKISH STANCE

If there was one big news in the Fed statement this week on December 13, 2023, it was that Fed finally bid farewell to its hawkish stance. Many experts had already contended that the Fed had been hawkish for much longer than required. On the one hand, it had delayed the start of rate hikes and then it had hiked the rates too fast. To add to that list of problems, the Fed had maintained its hawkish stance for too long. In a sense, the December 2023 Fed policy statement was a watershed moment in that it finally bid farewell to its hawkish stance. The hawkish stance of the Fed has been its hallmark since early 2022. In that period, the Fed had raised rates from the range of 0.00%-0.25% to the current range of 5.25%-5.50%. Now, the Fed is finally done and has shifted its approach to a more hawkish one.

The change in stance did not come easy for the Fed. It had to with a lot of macro variables falling in place. For starters, economists may still have arguments with the level of inflation but nobody can deny that the inflation has genuinely and materially come down in the last 22 months. Secondly, the Fed had managed to stave off a hard landing, despite most of the economists being sceptical about it. The latest GDP number of 5.2% in Q3, is just a testimony of that. Thirdly, with the labour data also showing that it was not contributing to excess inflation, the time was ripe for a change of stance. Whether the Fed adjusts to a new and higher normal of inflation is a different issue, but hawkishness has surely ended.

LONG TERM FED PROJECTIONS ALSO SHOW DOVISH TILT

The Federal Open markets Committee (FOMC) releases its long term estimates on key macroeconomic variables on a quarterly basis. The big shift this time is in GDP estimates. In June, the GDP estimate for 2023 was 1.1%, which was raised to 2.1% in September and has now been raised to 2.6% in December. That is a clear indication that hard landing is out and the economy is in good shape. Also, the inflation over the next two years is expected to show a quicker move towards the 2% target. But the real give away is the sharp downward movement in the Fed rate projections. This is entirely in sync with the 175 bps rate cuts that the Fed had pencilled by end of 2025 in its Fed statement on December 13, 2023.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED DECEMBER 08, 2023

The previous week to December 08, 2023 saw CME Fedwatch undergo a complete shift all over again. The first signs of the Fed diverging from the CME Fedwatch came in the previous week to December 08, 2023. While the Fed, at that point, had just factored in 2 rate cuts by end of 2023, the CME Fedwatch had already factored in up to 4-5 rate cuts by the end of 2023. In a sense, the CME Fedwatch stance got ratified in the subsequent week.

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.

• During that particular week, 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%, raising some questions on the growth front.

   

• In the week to December 08, 2023, 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. Not surprisingly, oil stabilized around the $75/bbl mark.

   

• 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 tapered in October 2023, showing weak non-US demand.

   

• The Atlanta Fed GDP estimates for Q4 are likely to come in at around 1.3%, but the actual estimate by the Atlanta Fed came in lower at 1.2%. That is indicative of some pressure on Q4 growth in the US, and that is something even the Fed has admitted to.

   

• Finally, the Fed balance unwinding is on track and, surprisingly, is having little impact on the market liquidity. Fed has unwound its bond book by $1.4 trillion from $9.1 trillion to $7.7 trillion. This week, the Fed bond book was further wound down to $7.6 trillion.

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

CME FEDWATCH IN THE LATEST WEEK TO DECEMBER 15, 2023

The week to December 15 had some major data points. For starters, the US consumer inflation was to be announced and the all-important Fed statement was expected to be out on December 13, 2023. To top it, the Fed was to also issue its quarterly update of macro projections for the next few years on key economic variables. The big question was whether the CEM Fedwatch was right in diverging so sharply from the Fed stance?

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.3%	89.7%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.8%	62.7%	30.5%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	5.6%	52.9%	36.1%	5.3%
Jun-24	Nil	Nil	Nil	Nil	Nil	5.1%	48.6%	37.7%	8.2%	0.5%
Jul-24	Nil	Nil	Nil	Nil	4.3%	41.9%	39.3%	12.7%	1.7%	0.1%
Sep-24	Nil	Nil	Nil	3.8%	37.4%	39.6%	15.9%	3.0%	0.3%	Nil
Nov-24	Nil	Nil	2.5%	25.9%	38.9%	24.0%	7.4%	1.2%	0.1%	Nil
Dec-24	Nil	2.0%	21.3%	36.3%	27.0%	10.7%	2.4%	0.3%	Nil	Nil

Data source: CME Fedwatch

There are 3 critical data points for the week and, in a sense, they all contributing to making it a watershed week for the Federal Reserve. 

• On Tuesday, the CPI inflation for November was announced. The consumer inflation came in 10 bps lower from 3.2% to 3.1%. This is largely as per the Bloomberg estimates, although the market analysts were expecting the consumer inflation to either touch 3% or even dip below that. While core inflation remained flat in the month, it was the food inflation and the fuel inflation that actually pushed the inflation lower by 10 bps.

   

• The last Fed policy of 2023 was announced on Wednesday, December 13, 2023. While the Fed did not hike rates as expected, there was a lot of dovishness hidden in the language of the Fed. For a change, the Fed committed to 3 rate cuts of 25 bps each in year 2024. In addition, it also committed to 4 additional rate cuts in 2025; making it a total of 175 bps of rate cuts by end of 2025. This is the first, and possibly, the clearest signal from the Fed that rate hikes are done and dusted. It is also the first visible shift by the Fed out of its hawkish stance, something that had been expected for the last few months. That shift has finally happened in the December Fed statement.

   

• In the aftermath of the monetary policy statement, the FOMC (Federal Open Markets Committed) also released its December quarter projections of key macroeconomic variables. The updated clearly showed that actual GDP growth in 2024 and 2025 would be higher than expected while the inflation would be lower than expected. It is a clear indication that the hard landing has been avoided and the Fed is good to move ahead now on its relatively dovish stance. 

On its part, the Fed statement was the big story this week as it signalled a shift away from its traditional hawkish stance. As the Fed shifted gears towards a more dovish next two years, the CME Fedwatch also started representing more realistic expectations.

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO DECEMBER 22, 2023

There are 3 critical triggers to watch out for in the coming week to December 15, 2023 with reference to CME Fedwatch. Due to the Christmas weekend, most of the key US data flows will now happen in the third week instead of the fourth week.

• On December 21, 2023, the third and final estimate of Q3 GDP will be put out by the Bureau of Economic Analysis (BEA). In the second estimate, the GDP had been upped by 30 bps to 5.2%. There are chances that the GDP may be kept  at the same rate or upped marginally. Either ways, it would be a boost for the new dovish stance of the Fed.

   

• On December 22, 2023, the PCE inflation estimate for November will also be out. The PCE inflation for October was already 20 bps below the consumer inflation, so the estimate is that November PCE inflation could dip below 2% mark. That would again be in sync with the broad Fed stance on rates and inflation.

   

• The Q4 Atlanta Fed GDP estimate will also be updated during the week on December 19,2023. The estimate has been at around 1.4% and that could be slightly out of sync with the strong performance in Q3. The Q4 estimate would be key to whether higher GDP growth was a flat in the pan or can be sustained in 2024 too.

For now, all eyes will be on the GDP update for Q3 and the PCE inflation, two important variables in the Fed’s overall scheme of looking at the macroeconomic narrative.

CME FEDWATCH VS FED STANCE: DICHOTOMY GETS MORE RATIONAL

There were two stages. In the run up to the Fed statement, the dichotomy had widened, but after the Fed shifted away from dovishness, actually the uncertainty was over and the gap between the CME Fedwatch and the Fed stance reduced. Here is how.

• On the upside, there appears to be a reasonable consensus. Last time, the CME Fedwatch had almost concluded that rate hikes were down and dusted. This time around, the CME Fedwatch and the Fed statement appear to be in sync that rate hikes are actually done and dusted.

   

• What about terminal rates? The Fed has now just indicated likelihood of rate hikes, should inflation persist. However, the dovish tilt of the Fed statement is clear indication that the Fed also believes that 5.25% to 5.50% is actually the terminal level of rates. 

   

• The real big gap is on the downside. While the Fed has now reconciled itself to 3 rate cuts in 2024 and 4 rate cuts in 2025, the CME Fedwatch expects that out of these, 6-7 rate cuts may be front-ended in the year 2024 itself. That may sound a little impractical but that is the stance that the CME Fedwatch has stuck. Of course, post the policy, the intensity of probabilities on the downside has surely sobered.

Eventually, it will depend on how the Fed interprets the data, and now it has given guidance on rate cuts for next two years. Even if we assume that the Fed has blinked first, it is apparent that the Fed has bid goodbye to hawkishness.