Weekly Musings – CME Fedwatch change for week to February 02, 2024

5 Feb 2024 , 09:20 AM

FED STATEMENT DISAPPOINTS MARKETS

The global markets had big expectations from the Fed policy on January 31, 2024. It ended up being a damp squib for the markets. At the end, the CME Fedwatch continued to hold on to its more dovish view on the rates, but by now few were willing to give it too much credence. The Fed disappointed in a number of ways. Firstly, the markets were expecting a time table on rate cuts. However, the Fed did not offer any such timetable. Instead, it confined itself to warning about the likely inflation risks. Secondly, the markets were expecting that the Fed would at least give a hint that the rate cuts were being front-ended in 2024. Instead, the only indication that came from the Fed was that the March rate cuts ruled out, leaving the markets to now fancy about rate cuts only in May or June.

Why did the Fed choose to disappoint the markets? Of course, the Fed has underlined that its primary job is to focus on price stability and ensuring near full employment. Hence, expecting the Fed to respond to growth stimulus was impractical in the first place. The Fed has underlined two risks to inflation. Firstly, the Red Sea crisis is still playing out and it is not year clear how much would be the impact on total trade. Also, due to its strategic location, the strife in West Asia and the Middle East is likely to have a major impact on oil prices. Secondly, the Fed has been concerned that the momentum of falling inflation was not visible any longer, since the Fed halted its rate hikes. The PCE inflation was still well above the target of 2% and the Fed was not keen on committing to rate cuts at this juncture. In short, the decision will continue to be data driven only.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JANUARY 26, 2024

In contrast to the previous weeks, the week to January 26, 2024 saw the CME Fedwatch sharply veer towards the Fed view. The rate cut expectations presumed in the CME Fedwatch came down from 175 bps to just 125 bps for calendar 2024. That is still aggressive, but sharply lower than what the CME Fedwatch was expecting about a few weeks back. The first dampener to the CME Fedwatch expectations came in the form of the previous Fed minutes, where were largely benign with no discussion on rate cuts. 

Later, even the Fed talk was largely favouring delaying the rate cuts till there was credible evidence of inflation coming down. Now, the January Fed statement has continued that stand and has put off the first possible rate cut to May or June 2024. That ambivalence has had a deep imprint on the CME Fedwatch reading of like rate cuts in the future. First, let us look at how the story evolved for CME Fedwatch in the week to January 26, 2024.

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	3.1%	96.9%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.4%	46.2%	52.3%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	1.1%	36.0%	50.9%	11.9%
Jun-24	Nil	Nil	Nil	Nil	Nil	1.1%	34.6%	50.3%	13.5%	0.5%
Jul-24	Nil	Nil	Nil	Nil	0.9%	30.2%	48.3%	18.4%	2.2%	0.1%
Sep-24	Nil	Nil	Nil	0.8%	27.3%	46.5%	21.3%	3.8%	0.3%	Nil
Nov-24	Nil	Nil	0.5%	16.1%	38.4%	32.0%	11.2%	1.8%	0.1%	Nil
Dec-24	Nil	0.4%	13.0%	34.0%	33.2%	15.3%	3.6%	0.4%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers in the week to January 26, 2024 with reference to the CME Fedwatch. 

• The first advance estimate (FAE) of Q42023 GDP growth came in better than expected. The Bloomberg peg for the Q4 GDP was at 2.0%, and the Atlanta GDP had pegged the growth rate at 2.4%. In a positive surprise, the actual GDP number, as per the FAE, came in sharply higher at 3.3%. The sharply higher GDP for Q3 meant full year GDP of closer to 2.6% or higher. This also does away with the risk of hard landing.

   

• PCE inflation was the other major policy trigger in the week. For December 2023, the PCE inflation came in flat at 2.6%. The components were more interesting. While fuel PCE inflation was sharply higher, the food PCE inflation and the core PCE inflation were sharply lower. In short, adjusted for the Red Sea effect, the actual PCE inflation could actually have been much lower. 

   

• The pressure of the Red Sea crisis was visible in API weekly inventories. It was expected to fall by 3.00 million barrels but ended up falling by 6.674 million barrels during the week. The larger than expected drawdown in inventories is an indication that the delays in movement of oil was taking its toll on oil prices. During the week to January 26, 2024, even the US 10-year bond yields trended higher at 4.14%.

Despite the positive signals from the PCE inflation and Q4 GDP estimates during the week, the CME Fedwatch continued to be sceptical. While the Fed talk continues to be hawkish, the Fed statement was the only hope for the CME Fedwatch about more dovishness.

CME FEDWATCH IN THE WEEK TO FEBRUARY 02, 2024

The recent week to February 02, 2024 was dominated by the Fed policy announcement and the statement by Jerome Powell. The table 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
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	19.5%	80.5%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	12.4%	58.2%	29.4%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	11.2%	54.0%	32.1%	2.7%
Jul-24	Nil	Nil	Nil	Nil	Nil	9.3%	46.6%	35.9%	7.8%	0.5%
Sep-24	Nil	Nil	Nil	Nil	8.9%	44.7%	35.6%	9.7%	1.0%	Nil
Nov-24	Nil	Nil	Nil	5.7%	32.1%	38.8%	18.9%	4.1%	0.4%	Nil
Dec-24	Nil	Nil	4.5%	26.5%	37.6%	23.1%	7.1%	1.1%	0.1%	Nil

Data source: CME Fedwatch

There were 3 critical triggers in the week to February 02, 2024 which had an influence on the CME Fedwatch. Here are the key triggers that impacted the structure of CME Fedwatch.

• The all-important Fed policy and the FOMC statement was issued by the Fed on January 31, 2024. The markets were awaiting a time table for the rate cuts and when the Fed plans to start. Unfortunately, the Fed not only refused to offer any time table for rate cuts, it also went on to caution the markets that any rate expectations in March were ruled out and the earliest one can expect rate cuts would be in May or June policy. That surely disappointed markets, that what was expecting a more affirmative statement.

   

• The other big story for the week was the OPEC meeting to decide on quotas. It was already clear that amidst the Red Sea crisis, the OPEC would not tighten supply any further. However, the OPEC did maintain status quo on the supplies and even commended the members on meeting quota cuts. However, with the exit of Angola from OPEC, the issue of OPEC unity continues to be the moot point.

   

• After the US GDP First Advance Estimate of 3.3% for Q4 was well above expectations, the Atlanta Fed estimate of GDP for the week for Q1 was pegged at 3.0%. In a positive surprise, the GDP estimate came in sharply higher at 4.2%. Even the unemployment level, that was pegged at 3.8%, came in sharply lower at 3.7%. It is, probably, hard evidence of the fact that the US economy has well and truly avoided a hard landing.

This is not a very busy week for data flows, but the markets will focus a lot more on the Fed member speak as well as the critical weekly data flows like the Atlanta GDP estimate, oil inventories, and the tapering of the Fed balance sheet.

 

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO FEBRUARY 09, 2024

There are 4 critical triggers to watch out for in the coming week to February 09, 2024 with reference to CME Fedwatch. Most of them are Fed Speak and data related.

• Fed chair Jerome Powell speaks on Sunday and that is going to be a critical data point for the CME Fedwatch. While Powell has been quite forthright about the merits of being conservative about rate cuts, the markets will look for clues. Another hawk, Michelle Bowman, will also be speaking during the week.

   

• With oil continuing to be volatile in recent weeks, the API weekly crude stocks will be closely watched. In the previous week, the stocks had depleted sharper than expected. Ini the coming week, depletion of -2.500 million barrels is expected to the oil stocks.

   

• Weekly estimate of Atlanta Fed GDP for Q1 will also be closely watched. Last week, the Q1 GDP estimate came in sharply higher at 4.2% against the estimate of 3.0%. This week, the estimate is already at 4.2%, so any further upsides will only underscore the fact that the hard landing has been well and truly avoided. However, that is likely to have limited impact on the rate decision.

   

• The Fed balance sheet has gradually come down to $7.63 trillion from a peak of $9.1 trillion. In short, the liquidity curtailment is magnifying the impact, even in the absence of rate hikes. That is expected to continue to taper in a methodical fashion.

With not too many big events in the coming week, the focus would largely be on the Fed member speak. Powell and Michelle Bowman will be closely watched for their generally hawkish comments. In addition, Bostic and Mester are also likely to speak this week. It is likely to be an interesting week of cues for CME Fedwatch.

CME FEDWATCH VS FED STANCE: GAP IS RAPIDLY REDUCING

During the previous week, the CME Fedwatch sharply cut its estimate of rate cuts from 175 bps in 2024 to just 125 bps in 2024. In the latest week to February 02, 2024, the trend is to drift more towards the Fed but stay in a broad range. The CME Fedwatch is now pegging rate cuts of 100 bps to 150 bps in 2024, with outliers gradually being eliminated. There are two key takeaways in terms of the divergence between CME Fedwatch and the official Fed stance as postulated in the recent Fed statement.

• On the upside, there broadly appears to be a consensus between the Fed and the CME Fedwatch. Both are almost agreeable that the rates have topped out around the current levels of 5.25%-5.50%; although the Fed is yet to officially acknowledge the same. There is also agreement that any further rate hike would only happen under very exceptional circumstances. It appears that, even in a very difficult scenario, the Fed may choose to hold rates higher for longer rather than hiking rates. On this front, the CME Fedwatch is likely to tail the Fed statements.

   

• The major dichotomy is still on the downside, as the CME Fedwatch stays aggressive; but the aggression clearly appears to be toning down. The Fed has already reconciled to 3 rate cuts in 2024 and 4 rate cuts in 2025, although it has been non-committal about the time table for such rate cuts. In the Fed statement on January 31, the Fed even explicitly ruled out any rate cuts till the May 2024 meeting. CME Fedwatch, in the previous week, has further toned down its rate cut expectations to the range of 100 bps to 150 bps in the current calendar year with a more likely rate cut of 125 bps. However, even that does look quite aggressive at the current juncture. 

At the end of the day, the Fed will still be data driven and the CME Fedwatch has no choice but to veer towards the Fed point of view. For now, Fed is holding a number of aces up its sleeve, but the market is not too sure what it actually plans. One thing is clear; the Fed will not allow market pressures to force its hand. The Fed statement has clarified that it will be price stability and full employment over GDP growth; when it comes to deciding policy rates.