Weekly Musings – CME Fedwatch change for week to January 26, 2024

29 Jan 2024 , 09:13 AM

CME FEDWATCH NOW APPEARS TO BE AMBIVALENT

Between the previous week and the current week, not much has changed in terms of the CME Fedwatch. For more than a month, the CME Fedwatch stuck its stance that the Fed would cut rates by 175 bps in the year 2024 itself. This is in contrast to the Fed statement that it planned to cut rates by 75 bps in 2024 and 100 bps in 2025. However, over the last 2 weeks, the aggression and the optimism of the CME Fedwatch has gradually eroded. Now, the CME Fedwatch has toned down its rate cut expectations from 175 bps to 125 bps in 2024, but it is still substantially higher than what the Fed has indicated. Remember, Fed continues to make hawkish overtures to the market and even in the latest Fed minutes, the Federal Reserve was totally silent about the time table to cut rates in the US.

What has crept in now is a feeling of ambivalence. The CME Fedwatch continues to be optimistic about rate cuts and the reasons are not far to seek for two reasons. Firstly, the PCE inflation has stabilized at 2.6%, which is just about 60 bps away from the Fed target. The pressure is coming from higher fuel prices while food inflation and core inflation are down. Adjusted for the Red Sea crisis, the actual rates should be lower than 2.6%. Secondly, the Q4 GDP data shows that the US may have avoided a hard landing with Q4 GDP growth coming in at 3.3%. Then, why the ambivalence. For starters, the Fed is yet to give a signal that rates have peaked and the Fed speak continues to be at odds with the view given by Powell in his Fed statement. Also, due to the Red Sea crisis, the Fed is not too sure about when and whether to start rate cuts, and with robust GDP, the Fed can actually afford to wait.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JANUARY 19, 2024

In contrast to the previous weeks, the week to January 19, 2024 saw the CME Fedwatch sharply move towards normalization. The aggression in the CME Fedwatch came down from a total of 175 bps rate cut expectations to just 125 bps rate cut expectations. That is substantial and was driven by the Fed minutes being silent on time table of rate cuts. In addition, the Fed speak during the week was also very hawkish and the Fed was playing safe amidst the worsening Red Sea trade crisis.

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	2.1%	97.9%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	46.2%	52.9%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	0.7%	33.1%	50.9%	15.2%
Jun-24	Nil	Nil	Nil	Nil	Nil	0.6%	31.8%	50.2%	16.7%	0.6%
Jul-24	Nil	Nil	Nil	Nil	0.6%	27.7%	47.8%	21.1%	2.7%	0.1%
Sep-24	Nil	Nil	Nil	0.5%	25.0%	45.8%	23.8%	4.6%	0.3%	Nil
Nov-24	Nil	Nil	0.3%	15.2%	37.4%	32.6%	12.3%	2.0%	0.1%	Nil
Dec-24	Nil	0.2%	12.2%	33.0%	33.6%	16.3%	4.1%	0.5%	Nil	Nil

Data source: CME Fedwatch

The week saw the CME Fedwatch moderate its expectations on rate cuts to just 125 bps in 2024, from  175 bps in the previous week. Here are some data points.

• Several Fed officials spoke during the week; including Waller, Bowman, Williams, and Bostic. The tone was almost similar. Fed officials were expected to provide guidance on whether the Fed really plans to cut rates in the current year and, if so, by how much. In reality, the Fed members avoided specific guidance. CME Fedwatch is already factoring in back-ending of rate cuts with most of the rate cuts happening in the second half of 2024. Fed members, ironically, have not ruled out the possibility of rate hikes, should inflation spiral out of control due to the ongoing Red Sea crisis.

   

• The Atlanta Fed GDP (GDP growth estimate) was another key data point. It gives an advance estimate of Q4 GDP in the US. Last week, estimates of GDP for Q4 had come in lower at 2.2%. For the week to January 19, 2024, the Atlanta GDP estimate was raised to 2.4% and the Atlanta Fed GDP actually met that target. The Atlanta Fed GDP is considered one of the most authentic estimates of GDP, which goes in as an input into the GDP number across the first advance estimate, second estimate and final estimate.

   

• API crude inventories and the Fed balance sheet update were also under close scrutiny during the week to January 19, 2024. The Fed balance sheet was marginally lower at $7.67 trillion, indicating that bonds worth nearly $1.5 trillion are already unwound. That magnifies the impact of rate hikes and tightens liquidity. After API crude stocks had fallen by -5.215 million barrels in previous week, this week was expected to see a drawdown of -2.400 million barrels. However, the week actually saw oil crude stocks increase by +0.483 million barrels. However, the Red crisis continued to be an overhang.

Interestingly, in the previous week, the US bond yields spiked sharply while the US dollar index (DXY) was also slightly higher; reacting to higher inflation and hawkish Fed talk. These two variables must be closely tracked, as they give hints about CME Fedwatch trajectory.

CME FEDWATCH IN THE WEEK TO JANUARY 26, 2024

The recent week to January 26, 2024 was a relatively quiet week with 2 very critical data points other than Fed-speak. 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
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 are 3 critical triggers to watch out for in the coming week to January 26, 2024 with reference to CME Fedwatch. 

• The first advance estimate (FAE) of Q42023 GDP growth came out on Thursday. The Bloomberg peg for the Q4 GDP was at 2.0%, and the Atlanta GDP has pegged the growth rate at 2.4%. However, the actual GDP number came in sharply higher at 3.3%. Growth was seen services and non-durable goods. The sharply higher GDP for Q3 means that full year GDP estimate could be 2.6% or higher. This also does away with the risk of hard landing; and almost confirms that the US economy has soft landed.

   

• PCE inflation was the other major trigger in the week, especially after the consumer inflation for December 2023 spiked by 30 bps. PCE inflation came in flat at 2.6%. However, it must be remembered that while the fuel PCE inflation was sharply higher, the food PCE inflation and the core PCE inflation were sharply lower. That means, adjusted for the Red Sea crisis, the PCE inflation may be lower than 2.6%. However, it remains to be seen if the Fed uses this data to give any firm commitments on the rate cut time table in its January 31, 2024 Fed statement.

   

• The pressure of the Red Sea crisis was visible in the API weekly inventories. It was estimated to fall by 3.00 million barrels but ended up falling by 6.674 million barrels during the week. That is clear indication that the oil movement crisis is creating a major pressure on the oil inventories in the US. This tends to boost oil prices globally. Also, the 10 year bond yields in the US remained slightly higher at 4.14% while the dollar index was stable between the range of 103 and 104 for the week. All eyes will be on the Fed policy statement in the last week of January 2024.

For now, the market has got positive signals from the PCE inflation and Q4 GDP estimates during the current week. A lot will now predicate on how the Fed policy pans out in the coming week.

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO FEBRUARY 02, 2024

There are 3 critical triggers to watch out for in the coming week to February 02, 2024 with reference to CME Fedwatch. Here are the key triggers for the coming week.

• The all-important Fed policy and the FOMC statement will be out this week. Markets will not only track the policy statement but also the post policy conference for what Powell ahs to say. For now, the markets are interested in a time table for the rate cuts and when the Fed plans to start. Till that actually comes about, everything just boils down to speculation. Hopefully, the time table should come through in this statement.

   

• There is the OPEC meeting in the coming week and it is material since the stickiest part of inflation today is not food inflation or core inflation, but oil inflation. The OPEC is likely to announce some clarity on the outlook for the oil trade, since most of the leading oil traders are abandoning the Red Sea route. The GCC nations are also concerned that it does not spread to the Gulf of Hormuz, the hub of Middle East oil trade. The OPEC meet outcome will be closely watch for clarity on this issue.

   

• The focus will also be on the Atlanta GDP estimate for the second estimate. The first estimate of GDP came in sharply higher than the Atlanta Fed estimate at 3.3%. That will now force the Atlanta Fed to also update its forecasts. The API stocks will also hold the key in this week after the oil stocks in the US fell by -0.667 million barrels last week.

All eyes will be on Jerome Powell and the Fed statement in the upcoming monetary policy to be announced on January 31, 2024. With oil holding the keys to inflation, the OPEC meeting will also assume a lot of significance in the coming week.

CME FEDWATCH VS FED STANCE: GRAVITATING TOWARDS OFFICIAL STANCE

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. However, the data has not changed much in this week, barring some very peripheral changes to the probabilities. There are two key takeaways here in terms of the divergence between CME Fedwatch and the official Fed stance.

• On the upside, there broadly appears to be a consensus between the Fed and the CME Fedwatch. Both are now agreeable that the rates have topped out around the current levels of 5.25%-5.50%. There is also agreement that any further rate hike would only under exceptional circumstances. However, it looks like the Fed may hold rates higher for more time and, on that, there is not much agreement between the US Federal Reserve and the CME Fedwatch. 

   

• The major dichotomy is still on the downside, as the CME Fedwatch stays aggressive. However, the extent of aggressive has toned down very significantly. The Fed has 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. We are not sure if the January policy offers any time table. CME Fedwatch, in the previous week had toned down its rate cut expectations from 175 bps to 125 bps; and that has stayed in this week also. However, the rate cut expectations of the CME Fedwatch are still significantly higher than what the Fed has hinted at.

At the end of the day, the Fed will still be data driven. For now, Fed is holding a number of aces up its sleeve, but the market is not too sure what it means. One thing is clear; the Fed will not allow market pressures to force its hand. Like in the past, it is the CME Fedwatch that may have to eventually reconcile.