Weekly Musings – CME Fedwatch change for week to December 29, 2023

31 Dec 2023 , 08:19 AM

DID THE CME FEDWATCH GETS ITS RATE PROJECTIONS RIGHT IN 2023?

Today, the big dichotomy in the US market is the vast dichotomy between what the Fed thinks and what the CME Fedwatch is indicating. For instance, the Fed has guided that it will cut rates by 75 bps in year 2024 and by another 100 bps in year 2025. However, the CME Fedwatch is of the view that the entire 7 rate cuts of 175 bps will happen before the end of 2024 itself. That is aggressive, but that is how the market feels about the future trajectory of interest rates. As we come to the end of year 2023, we look back at what the CME Fedwatch at the start of 2023 and at the middle of 2023 and what it is today.

WHAT THE CME FEDWATCH INDICATED AT THE START OF 2023

The table below captures the gist of what the CME Fedwatch expected about Fed rates at the start of 2023. It must be remembered here that the CME Fedwatch presents market driven probabilities of rate hikes after the various Fed meetings during the next one year. This is based on Fed futures trading. Here is the table of probabilities in early January 2023.

Fed Meet	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575	575-600
Feb-23	Nil	Nil	Nil	68.1%	31.9%	Nil	Nil	Nil	Nil
Mar-23	Nil	Nil	Nil	10.8%	62.40%	26.8%	Nil	Nil	Nil
May-23	Nil	Nil	Nil	6.1%	40.1%	42.2%	11.6%	Nil	Nil
Jun-23	Nil	Nil	Nil	5.7%	37.8%	42.1%	13.6%	0.8%	Nil
Jul-23	Nil	Nil	1.1%	12.1%	38.7%	36.4%	11.1%	0.6%	Nil
Sep-23	Nil	0.4%	5.0%	21.4%	37.95%	27.5%	7.4%	0.4%	Nil
Nov-23	0.2%	2.3%	11.8%	28.3%	33.6%	19.2%	4.5%	0.2%	Nil
Dec-23	1.3%	9.2%	23.7%	32.1%	23.1%	8.5%	1.4%	0.1%	Nil

Data source: CME Fedwatch

What do we gather from the CME Fedwatch at the start of 2023. Back then, their view was that the rate of interest would touch the range of 4.75% to 5.00% by the end of 2023. However, that was far from the truth as in reality, the Fed had almost moved to the current rate of 5.25% to 5.50% by the third quarter of 2023 and had held on since then. The CME Fedwatch in January had underestimated the hawkishness of the Federal Reserve.

WHAT THE CME FEDWATCH INDICATED IN JUNE 2023

Having seen how the CME Fedwatch projections looked like in early 2023, the table below looks at how the CME Fedwatch saw the rate projections at the middle of 2023. We have taken mid-June as the benchmark. The table below captures the story.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450- 475	475-500	500- 525	525-550	550-575
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	30.6%	69.4%	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	25.7%	63.2%	11.1%
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	2.2%	28.9%	58.8%	10.2%
Dec-23	Nil	Nil	Nil	Nil	Nil	0.5%	8.1%	35.5%	48.1%	7.9%
Jan-24	Nil	Nil	Nil	Nil	0.2%	3.9%	20.5%	41.2%	29.8%	4.3%
Mar-24	Nil	Nil	Nil	0.1%	2.6%	14.4%	33.5%	34.0%	13.8%	1.6%
May-24	Nil	Nil	0.1%	2.5%	14.2%	33.3%	34.0%	14.1%	1.8%	Nil
Jun-24	Nil	0.1%	1.7%	10.0%	26.3%	33.7%	21.3%	6.2%	0.7%	Nil
Jul-24	0.1%	1.4%	8.9%	24.2%	32.8%	23.0%	8.2%	1.4%	0.1%	Nil

Data source: CME Fedwatch

By June 2023, the rates of interest were already in the range of 5.00% to 5.25%. At that point, the CME Fedwatch expected the rates to touch the range of 5.25% to 5.50% between July and September which was correct. The CME Fedwatch was also right in pegging that as the peak of the rate cycle. However, the CME Fedwatch was expecting the Fed to cut rates by nearly 100 bps before the end of December 2023, which obviously did not happen as the Fed had stuck to the “higher for longer” formula. The moral of the story is that there is enough reason to believe that the CME Fedwatch often gets its longer term estimates off target. Let us now turn to the weekly story.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED DECEMBER 22, 2023

The previous week to December 22, 2023 saw CME Fedwatch clearly veering towards a more aggressive approach to rate cuts. While the Fed, at that point, had just factored in 2 rate cuts by end of 2024, the CME Fedwatch had already factored in up to 4-5 rate cuts by the end of 2024. You can check the CME Fedwatch probability chart.

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	14.5%	85.5%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	12.4%	75.6%	12.0%
May-24	Nil	Nil	Nil	Nil	Nil	0.4%	14.5%	73.6%	11.6%	Nil
Jun-24	Nil	Nil	Nil	Nil	2.1%	21.4%	66.2%	10.2%	Nil	Nil
Jul-24	Nil	Nil	Nil	1.9%	20.1%	63.1%	14.1%	0.7%	Nil	Nil
Sep-24	Nil	Nil	1.7%	18.3%	58.8%	19.0%	2.1%	0.1%	Nil	Nil
Nov-24	Nil	1.0%	11.2%	41.5%	36.0%	9.3%	0.9%	Nil	Nil	Nil
Dec-24	0.8%	8.8%	34.4%	37.3%	15.5%	2.9%	0.2%	Nil	Nil	Nil

Data source: CME Fedwatch

There were 3 triggers in the previous week to December 22, 2023 with reference to CME Fedwatch. The key last week US data like the PCE inflation and the GDP estimates were announced in the third week itself. Here were the key takeaways.

• On December 21, 2023, the third and final estimate of Q3 GDP was announced by the Bureau of Economic Analysis (BEA). It may be recollected that the second estimate had upped GDP estimates by 30 bps to 5.2%; but the third estimate reverted back to 4.9%. It was a case of weaker nominal GDP in the third quarter for the US economy. 

   

• On December 22, 2023, the PCE inflation estimate for November came in sharply lower at 2.6%. This is critical as it takes the inflation almost close to the 2% target. That is 80 bps lower than September and 40 bps lower than October. With sharply lower PCE inflation, the Fed could intensify its dovishness; by sharper rate cuts or by front-ending.

   

• The Q4 Atlanta Fed GDP estimate towards the end of the week saw sharply lower estimate of 2.3%, compared to 2.7% at the start of the week. This is an indication that the Q4 US GDP could be weaker than expected. However, full year GDP growth projection of 2.6% is still likely to be defended.

While the GDP growth is work in progress, it is the sharply lower PCE inflation that is the significant factor impacting the CME Fedwatch. More than anything else, the lower PCE inflation would only reinforce the dovishness of the Federal Reserve. We will get to see the impact in the next few meetings of the US Federal Reserve.

 CME FEDWATCH IN THE LATEST WEEK TO DECEMBER 29, 2023

The week to December 29 was a relatively quiet week with not too many data points. The normal month-end data points like the PCE inflation and the GDP estimates had been pushed back to the third week of December on account of the Christmas and New Year holidays in the US. The table below captures the Fed Futures probabilities.

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	16.5%	83.5%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	13.9%	72.8%	13.4%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	13.4%	70.6%	15.6%	0.5%
Jun-24	Nil	Nil	Nil	Nil	0.9%	17.3%	66.8%	14.5%	0.5%	Nil
Jul-24	Nil	Nil	Nil	0.8%	15.2%	60.2%	21.4%	2.3%	0.1%	Nil
Sep-24	Nil	Nil	0.7%	14.0%	56.6%	24.5%	3.8%	0.2%	Nil	Nil
Nov-24	Nil	0.5%	8.9%	40.3%	36.8%	11.8%	1.6%	0.1%	Nil	Nil
Dec-24	0.4%	7.3%	34.1%	37.5%	16.7%	3.6%	0.4%	Nil	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers to watch out for in the week to December 29, 2023 with reference to CME Fedwatch. Of course, being the last week of the year, it was relatively quiet as it was holiday season all around. Here are the two triggers.

• The API stocks would be closely watched for signals on oil prices last week, the oil stocks were expected to see a sharp fall, last week but instead expanded by 0.939 million barrels. In the current week, it expanded further to 1.837 million barrels and that is likely to put further pressure on crude oil prices. The crude has already fallen from $100 to $76/bbl and if the US reserves are increasing, then it is bearish for oil. However, that should help the US economy keep energy inflation under check.

   

• With the last week of the year being low on data, the markets will be closely watching the US bond yields and the US dollar index (DXY). During the current week, the US bond yields fell below 3.8% but eventually settled above 3.8%, sharply lower than the mark about 2 months ago. Even the dollar index briefly dipped below 101, before settling at just above 101; sharply lower than the 107 levels seen in September this year. 

For now, all eyes will be on the consumer spending during the Christmas week as it will set the tone for consumer spending reading for the coming quarter. For now, it looks like a record year end of spending for the US economy.

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO JANUARY 05, 2024

There are 3 critical triggers to watch out for in the coming week to January 05, 2024 with reference to CME Fedwatch. Here are the key triggers in the coming week.

• The Atlanta Fed GDP will be the key data point. It gives an advance estimate of Q4 GDP in the US and it is now hinting at stabilizing at around 2.3%. Now that should still help the US economy to report 2.6% GDP growth for the full year, a full 160 bps higher than the original estimate of 1%. However, this does dispel concerns that there could be a hard landing for the US economy. That is almost ruled out for now.

   

• The minutes of the FOMC meeting will be announced on January 03, 2023 and that will contain critical cues to the shape of monetary policy in the months to come. We already know that the Fed is talking about 3 rate cuts in 2024 and 4 rate cuts in 2025. The minutes and the language of the members will tell us if there are chances that the Fed would get more aggressive and front-end rate cuts.

   

• API crude stocks and the unemployment ratio will be the other key factors to look at. The API stocks touched a positive 1.837 million barrels and is likely to increase further, putting further pressure on the crude prices and reducing inflation reading. However, there are signals of the labour market loosening with unemployment likely to go up to 3.8% this week.

For the week, all eyes will be on the Fed minutes. After all, it was the Fed statement that had triggered the bull rally globally. The minutes will tell the real story.

CME FEDWATCH VS FED STANCE: STABLE OVER LAST WEEK

The dichotomy between CME Fedwatch and the Fed stance is still there, but now it appears to have stabilized. Broadly, the gist remains the same, barring some minor changes.

• On the upside, it appears that rate hikes are done and dusted. CME Fedwatch expects rate cuts to start in March, but Fed has not committed to any time line. 

   

• There appears to be an agreement that terminals rates have been reached at 5.25%-5.50%, although the Fed may still not admit to it publicly. 

   

• The dichotomy on the downside continues as before. Fed has reconciled to 3 rate cuts in 2024 and 4 rate cuts in 2025. CME Fedwatch expects all 7 rate cuts to happen in 2024. Fed has reasons to front-end cuts, but it is ambivalent on whether to do it. 

Eventually, Fed would still prefer to be data drive; and that is what they will continue to do. For now, it does look like; the Fed has bid goodbye to any form of hawkishness!