Weekly Musings – CME Fedwatch change for week to January 12, 2024

15 Jan 2024 , 11:56 AM

WHAT EXPLAINS THE FED – CME FEDWATCH DICHOTOMY

In the last 2 weeks, there were two occasions when there were reasons to question the patently dovish viewpoint of the CME Fedwatch. Firstly, there were the Fed minutes in the previous week, which did not spell out anything about the rate cuts; leave alone providing any time line or time table for rate cuts. In the current week, the US inflation came in 30 bps higher at 3.40%. This does raises questions about whether the CME Fedwatch is being too optimistic about rate cuts. For instance, the Fed had estimated 3 rate cuts of 75 bps in 2024 and 4 rate cuts of 100 bps in 2025. However, Fed had cautioned that this action would still be circumscribed by the data. However, the CME Fedwatch continues to bet on 175 bps of rate cut being front-ended in the year 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, the Fed has now given enough indications that they would not be too keen to play ball with the doves, unless the inflation is decisively lower. That is what is the question now, since at 3.40%, the consumer inflation is a full 140 basis points above the avowed Fed target of 2% inflation. It is getting harder and harder by the day to explain the relentless dovish enthusiasm of the CME Fedwatch.

US INFLATION IS THE NEW JOKER IN THE PACK

Just a week after the Fed minutes disappointed the street by not announcing anything concrete on the rate cut time table, it was the turn of inflation to be the joker in the pack. One can argue that the Fed considers the PCE inflation, and not the consumer inflation for its rate decisions, but it is the consumer inflation that sets the tone for PCE inflation. The consumer inflation for December 2023 came in 30 bps higher for the US economy at 3.40%. While the food inflation and the core inflation trended lower, the pressure came from energy inflation as the Red Sea crisis had resulted in a spike in oil prices. The US inventories have been constantly seeing drawdowns and that is not helping oil prices either. The net result is that the Fed is now in a quandary. While it has committed to rate cuts, the inflation data appears to be indicating at static rates, if not at rate hikes from current levels.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JANUARY 05, 2024

Just as the CME Fedwatch clearly veering towards a more aggressive approach to rate cuts, the Fed minutes came in as a disappointment. While the Fed, at that point, had just factored in 3 rate cuts by end of 2024, and 4 by end of 2024, the CME Fedwatch had already factored in up to 7 rate cuts by the end of 2024 itself. In addition, the CME Fedwatch was also factoring in front-ending of rate cuts. 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	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 in the week to January 05, 2024 with reference to CME Fedwatch. Here is what had an impact on the CME Fedwatch during that week.

• The Atlanta Fed GDP is a critical data point when it came to projecting the likely GDP growth for the fourth quarter. We now have full data for 3 quarters and the first advance estimate of Q4 GDP is expected as of the end of January 2024. In the previous week, the Q4 GDP estimate by the Atlanta Fed had been further knocked down from 2.6% to 2.0%. However, in the recent weeks, the estimate for Q4 GDP growth appears to have stabilized at around 2.3% consensus. For now, it looks like the third quarter GDP spike was more an exception than the rule, due to a low base. However, the GDP data still looks to easily achieve the 2.6% target for full year 2023, although we have to wait till the end of March 2024 to get the final estimate of Q4 and also the final estimate of full year GDP for 2023.

   

• The minutes of the FOMC meeting were published by the Federal Reserve on January 03, 2024. Contrary to expectations, the Fed did not indicate that it would start the rate cut program soon. It did not even indicate that it had rate cuts on mind, leave alone giving any signal of the time table for rate cuts. In response, the CME Fedwatch scaled down its estimate of rate cuts for 2024 from 175 bps to 150 bps. One can say that the silence on the timetable of rate cuts by the Fed is rather disconcerting The minutes and the language of the members did not disclose anything about the rate cut program, and it appeared to be largely influenced by the evolving Red Sea crisis in West Asia.

   

• API crude stocks and the unemployment ratio were two other key factors in the week to July 05, 2024. API stocks were expected to dip 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. To an extent, this has been influenced by the disruption of shipping lines globally. With oil spiking, the concerns over energy inflation remain elevated and that has been subsequently borne out by the data on consumer inflation for December. The unemployment rate; expected at 3.8% in the week, came in lower at 3.7%.

Overall, the week had signalled that inflation could surge further and the silence of the Fed on rate cuts only exacerbated the situation.

 CME FEDWATCH IN THE WEEK TO JANUARY 12, 2024

The week to January 12, 2024 was a relatively quiet week with not too many data points; other than the inflation reading. 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	5.2%	94.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	76.9%	19.0%
May-24	Nil	Nil	Nil	Nil	Nil	0.4%	11.5%	71.0%	17.0%	Nil
Jun-24	Nil	Nil	Nil	0.1%	4.0%	30.8%	53.5%	11.5%	Nil	Nil
Jul-24	Nil	Nil	0.4%	6.0%	32.5%	50.4%	10.7%	Nil	Nil	Nil
Sep-24	Nil	0.4%	5.9%	32.0%	50.0%	11.5%	0.2%	Nil	Nil	Nil
Nov-24	0.3%	3.9%	22.5%	43.5%	25.4%	4.3%	0.1%	Nil	Nil	Nil
Dec-24	3.4%	18.8%	39.3%	29.0%	8.5%	0.9%%	Nil	NIl	Nil	Nil

Data source: CME Fedwatch

There are 3 critical triggers to watch out for in the week to January 12, 2024 with reference to CME Fedwatch. 

• The consumer inflation reading for the US economy for December 2023 came in 30 bps higher at 3.40%. That is nearly 20 bps higher than the street expectations and the spike in inflation is largely driven by energy inflation. It remains to be seen how the Fed reacts to the data, but it is now likely to start rate cuts later in the year. However, the CME Fedwatch still appears to be confident of 175 bps rate cuts. In fact, immediately after the inflation announcement at 3.4%, the CME Fedwatch had lowered its estimate of rate cuts for 2024 to 150 bps, but has now again raised it to 175 bps. 

   

• The Atlanta Fed GDP was another data reading that disappointed in the week. The reading of Q4 GDP was expected at 2.5%, but eventually came in at just 2.2%. For now, the concern would only be if the GDP estimate dips below 2% for Q4 2024. Hard landing for the US economy may be off the table; but sharp fall in GDP growth raises concerns.

   

• API crude stocks were again the big factor in the week. The API crude stocks had fallen by -7.418 million barrels in the previous week and was expected to fall by -1.2 million barrels in the current week. However, the actual fall in the API crude stocks came in at -5.215 million barrels, which is likely to keep the oil prices on the boil globally.

In the week, the consumer inflation was higher than expected and now we need to keep an eye on PCE inflation to check if it also rises in tandem.

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO JANUARY 19, 2024

There are 3 critical triggers to watch out for in the coming week to January 19, 2024 with reference to CME Fedwatch. Here are the key triggers for the coming week.

• Several Fed officials are likely to speak this week and their language will be closely tracked. Among the speakers this week are Waller, Bowman, Williams, and Bostic. The Fed officials are expected to provide guidance on whether the Fed really plans to cut rates in the current year and, if so, what is the time table. It is time for the Fed to come out and provide a clearer picture to the market.

   

• 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 2.2%. For now, the US economy would still be able to report 2.6% GDP growth for the full year. The current Bloomberg estimate for Atlanta Fed GDP for the week is still placed at 2.2%, although any stark underperformance or a fall below 2% should be cause for worry. 

   

• Two things that will be closely watched is the API crude inventories and the Fed balance sheet update. The Fed balance sheet is already down to $7.68 trillion, which means bonds worth $1.4 trillion are already unwound. That is good news. In addition, the API crude stocks had fallen by -5.215 million barrels in the last week and it is likely to deepen due to the Red Sea crisis. That could keep oil on the boil and the energy inflation will continue to stay at elevated levels.

Interestingly, in the previous week, the US bond yields and the US dollar index (DXY) were almost flat, despite sharply higher inflation. That is something to watch out for.

CME FEDWATCH VS FED STANCE: WHO CARES ABOUT INFLATION?

At least, that is what the CME Fedwatch appears to say as it was back to its dovish aggression just two days after the consumer inflation came in 30 bps higher at 3.4%.

• On the upside, it looks like the rate hikes are done and dusted. CME Fedwatch expects rate cuts to start in March, but Fed minutes were absolutely non-committal. However, the latest inflation reading at 3.4% could change equations.

   

• There appears to be an agreement that terminals rates have been reached at 5.25%-5.50%, but Fed is keeping its options open. With the Red Sea crisis worsening by the day, the spike in oil prices is likely to continue. In that case, if consumer inflation remains intransigent, the Fed may have reasons to relook at the peak rate argument.

   

• The dichotomy on the downside continues, and the CME Fedwatch stays as aggressive as ever. Fed has reconciled to 3 rate cuts in 2024 and 4 rate cuts in 2025, although it has been non-committal in the minutes. CME Fedwatch had toned down its expectation from 7 rate cuts to 6 rate cuts in 2024 after the inflation reading was out. However, with higher inflation, it once again looks like the CME Fedwatch may have jumped the gun.

Eventually, Fed still be data driven. In a volatile scenario, the Fed is still playing its cards close to its chest.