Weekly Musings – CME Fedwatch change for week to January 05, 2024

8 Jan 2024 , 09:28 AM

IS THE CME FEDWATCH BEING OVERLY OPTIMISTIC

In the aftermath of the Fed minutes (we will look at this point separately), it does make one wonder if the CME Fedwatch is being overly optimistic. Let me explain. When the Fed presented its December policy, the statement was quite explicit that it would implement 3 rate cuts in 2024 and 4 rate cuts in 2025. That would have meant about 175 bps of rate cuts over the next two years. However, the CME Fedwatch continued to remain optimistic. It ahs been factoring that all 7 rate cuts of 175 bps would happen in 2024 itself. 

CME Fedwatch does not project for more than a year, so the 2025 position would only be clear once we traverse through 2024. However, after the Fed minutes did not commit to anything, the CME Fedwatch reduced its estimate of rate cuts to 150 bps in 2024. That is still double of what the Fed has already indicated. That has impelled some of the analysts to wonder if the CME Fedwatch was being overly optimistic about the pace of rate cuts by Fed.

FED MINUTES AND THE RED SEA CRISIS

The Fed minutes announced during the recent weed stood out for two things. Firstly, it disappointed the markets as it gave no indication of the timetable for rate cuts. In fact, the minutes did not even talk about the possibility of rate cuts in the near future and that resulted in the US bond yield and the US dollar index going up sharply. In a way, the Fed not talking about rate cuts was disappointing for the markets. The second key announcement in the Fed minutes was the detailed discussion on the Red Sea crisis. 

Obviously, the Fed expects the Red Sea standoff to have a larger than anticipated impact on crude prices. That would push up the US inflation levels and make rate cuts out of sync with the inflation reality. Already, the inflation reading for December is expected to be higher than the 3.1% reported last month. In such an eventuality, the Fed would want to keep option of hiking rates open, in order to curb inflation. That is not great news for markets.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED DECEMBER 29, 2023

The previous week to December 29, 2023 saw CME Fedwatch clearly veering towards a more aggressive approach to rate cuts. While the Fed, at that point, had just factored in 3 rate cuts by end of 2024, the CME Fedwatch had already factored in up to 6-7 rate cuts by the end of 2024. Also, the CME Fedwatch was expecting a lot of aggression. It expected that up to 4 rate cuts would happen by July and the remaining cuts in the last 5 months of year 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	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, 2024 with reference to CME Fedwatch. It was supposed to be a relatively uneventful week due to the Christmas and New Year holidays.

• The API stocks were 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 was expected to put further pressure on crude oil prices. However, the Red Sea crisis has been worsening in the last few weeks with freight rates on the route going up multi-fold after the Houthi rebels in Yemen fired missiles at Red Sea cargo. 

   

• Being the last week of the year, the focus had been largely on the two popular indicators viz., the US bond yields and the US dollar index (DXY). During the previous week, the US bond yields had fallen sharply below 3.8% but eventually settled above 3.8%. It may be recollected that bond yields in the US had touched the level of 5% just a couple of months back. In addition, the dollar index (DXY) briefly dipped below 101, before settling at just above 101. However, that is still sharply lower than the 107 levels seen in September this year. That had also been relatively subdued.

   

• Spending remained robust during the Christmas and New Year week with record sales noted at most consumer check points. It was more about the robust labour and wage data, that appeared to be helping the consumer spending growth, even in the midst of inflation risks in the market.

 CME FEDWATCH IN THE LATEST WEEK TO JANUARY 05, 2024

The week to January 05, 2024 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	6.2%	93.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.0%	62.3%	33.8%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	3.1%	48.9%	10.3%	7.7%
Jun-24	Nil	Nil	Nil	Nil	Nil	2.9%	47.2%	40.6%	9.0%	0.3%
Jul-24	Nil	Nil	Nil	Nil	2.5%	40.4%	41.6%	13.8%	1.6%	Nil
Sep-24	Nil	Nil	Nil	2.2%	38.9%	41.5%	17.1%	3.1%	0.2%	Nil
Nov-24	Nil	Nil	1.4%	23.7%	39.4%	26.0%	8.2%	1.3%	0.1%l	Nil
Dec-24	Nil	1.1%	19.3%	16.3%	28.6%	11.7%	2.6%	0.3%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers to watch out for in the coming week to January 05, 2024 with reference to CME Fedwatch. Here is what had an impact on the CME Fedwatch in the latest week to January 05, 2024.

• The Atlanta Fed GDP is the key data point, when it comes to projecting the likely GDP growth for the fourth quarter. It gives an advance estimate of Q4 GDP in the US and it had been hinting at stabilizing at around 2.3%. However, in the current week, the Q4 GDP estimate by the Atlanta Fed was further knocked down to 2.0%. In short, the estimate has fallen by 60 bps in just the last 2 weeks. It can possibly still help the US economy to report 2.6% GDP growth for the full year; but it will raise concerns that the third quarter spike in GDP growth could be more of an exception than a rule. Already, there have been confident statements that the US economy had avoided a hard landing; and it is only hoped that such enthusiasm is not too premature.

   

• The minutes of the FOMC meeting were published by the Federal Reserve on January 03, 2023. Contrary to expectations, the Fed neither indicated that it would start the rate cut program soon, nor did it indicate the quantum and timetable for the rate cuts. The markets were expecting a lot more and obviously, the CME Fedwatch immediately scaled down its estimate of rate cuts for 2024 from 175 bps to 150 bps. Fed has been talking about 3 rate cuts in 2024 and 4 rate cuts in 2025. However, silence on the timetable is rather disconcerting The minutes and the language of the members did not disclose anything about the timelines for rate cuts, amidst rising geopolitical uncertainty.

   

• API crude stocks and the unemployment ratio were the two other key factors in the latest week. The API stocks were expected to turn to negative from +1.837 million barrels to -2.967 million barrels. However, the fall in inventories was much deeper in the week at -7.418 million barrels. The falling inventories, along with the worsening geopolitical risk in West Asia, also contributed to the spike in oil prices. It is likely to put further pressure on inflation. However, the unemployment rate, which was expected to come in at 3.8% this week, has come in lower at 3.7%.

The action shifts to the December inflation reading that would put out in the coming week.

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO JANUARY 12, 2024

There are 4 critical triggers to watch out for in the coming week to January 12, 2024 with reference to CME Fedwatch. Here are the key triggers for the coming week.

• The consumer inflation reading is expected to come in this week for the US economy. The yoy inflation for December is likely to be higher by 10 bps at 3.2%, compared to 3.1% in the previous month. This will be despite a 20 bps fall in the core CPI as the higher crude prices are likely to put pressure on energy inflation. The Fed still looks at PCE inflation for its rate decisions, but it is the consumer inflation announced by the US Bureau of Labour Statistics (BLS) that sets the tone for prices in the US.

   

• The Atlanta Fed GDP will be another key data point. It gives an advance estimate of Q4 GDP in the US and it is now hinting at lower levels of 2.0%. For now, the US economy would still be able to report 2.6% GDP growth for the full year. However, should the Atlanta Fed GDP dip below 2%, then the pressure will be visible when the first estimate of full year GDP comes out towards the end of January. While a hard landing for the US economy may be well off the table; a sharp fall in GDP growth would raise concerns.

   

• After a gap, focus will return to Fed member speak. This week Fed members Williams and Bostic will be speaking on the Fed stance. The markets are expecting these speeches by the Fed members to provide what the minutes did not provide; which is guidance on rate cuts. It remains to be seen if the members actually do that.

   

• API crude stocks will continue to be the big factor. Last week, the API crude stocks reported by the American Petroleum Institute showed crude inventories falling by -7.418 million barrels, which also contributed to the spike in oil prices. With Red Sea supplies getting disrupted, the drawdown on inventories could only intensify.

In the coming week, the big news will be the consumer inflation in the US. The markets will be OK, if the inflation spike is restricted to just about 10-20 basis points.

CME FEDWATCH VS FED STANCE: STABLE OVER LAST WEEK

The dichotomy between CME Fedwatch and the Fed stance is still there, but CME Fedwatch appears to have tone down its optimism, post the Fed minutes.

• On the upside, it appears that rate hikes are done and dusted. CME Fedwatch expects rate cuts to start in March, but Fed minutes were absolutely non-committal.

   

• There appears to be an agreement that terminals rates have been reached at 5.25%-5.50%, but Fed is keeping its options open if oil spikes due to Red Sea crisis.

   

• The dichotomy on the downside continues, but has toned down. Fed has reconciled to 3 rate cuts in 2024 and 4 rate cuts in 2025. CME Fedwatch toned down its expectation from 7 rate cuts to 6 rate cuts in 2024. However, the Fed minutes were disappointing in that the Fed did not give any tangible indication that rate cuts will start soon.

Eventually, Fed still be data driven. For now, it looks like the Fed is still playing its cards close to its chest.