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

6 Jul 2024 , 09:25 AM

WHY THE FED IS NOT YET READY TO CUT RATES?

If you were to compress the pages of content on the minutes of the FOMC policy in one sentence, it is just that “Fed is not yet ready to cut rates.” Rather, the FOMC members find it a lot more convenient and less risky to maintain status quo than to take the risk of cutting rates at this juncture. Here is what we read from the FOMC minutes published by the US Federal Reserve during this week on July 03, 2024.

• Behind the rising tide of scepticism in the Fed, the only positive news is that the inflation is moving in the right direction. That means; the inflation is decisively moving lower and promises long run price stability. However, the limited movement in the PCE inflation in the last 5 months has made the FOMC members cautious that the pace of the fall in inflation is not as frenetic as they had hoped for.
• As of now, the FOMC members did not display any consensus on when to start rate cuts. The only consensus at this juncture is that the Fed must not be in a hurry to cut rates. That is because; in a rate cut decision, any reversal can be tough and expensive. More than the concerns of inflation not falling fast enough, it appears to be a fear of the unknown; as to what could happen if rate cuts triggered inflation all over again?
• It is said that the best thing to do when you are ambivalent is to wait for more data. For now, that is what the Fed is doing. They are looking for more data confirmation in the form of consumer inflation, non-farm payrolls, Q2-GDP advance estimates, oil price outlook, decisions of the OPEC on supply, week-on-week data on US oil reserve drawdowns, US consumer confidence etc. Once all or most of these indicators point to 2% inflation; only then will the Fed move on rate cuts.
• What was the gist of the apprehension that the FOMC members had? It could best be summed up in one sentence; “Members did not expect it would be appropriate to lower the target range for the federal funds rate until additional information had emerged to give greater confidence that inflation was moving toward the FOMC’s 2% objective in a sustainable manner.” It is true that last mile inflation has been stickier than usual but that is largely due to the intransigence of fuel prices.
• The dot plot chart of the Fed members does hint at a consensus that only one rate cut would be possible in 2024, although the Fed is open to the idea of compensating with more aggression in 2025. As of now, the best-case scenario is of just about one rate cut in 2024, and that too by 25 bps. In contrast, the Fed had earlier indicated 3 rate cuts by 2024 end. As per the CME Fedwatch Fed may be erring on the side of caution. CME Fedwatch expects 50 bps rate cut in 2024, with another 4-5 cuts in 2025.
• Members did differ on the need and feasibility of a rate hike in a worst-case scenario, should inflation spike from the current levels. Some of the hawkish members still wanting to keep the option to hike rates open. Ironically, the last statement by Jerome Powell had almost closed the door on rate hikes. However, it emanates from the minutes there was not too much buy-in for the rate hike argument. However, there was also consensus among members on some of the points. For example, almost all the members of FOMC saw economic growth “gradually cooling” and also felt that the current policy was “restrictive” enough. In short, US monetary policy was on track!

Powell captured this dichotomy quite eloquently. “ The risks of cutting too soon and risking a resurgence in inflation against cutting too late and endangering economic growth have come more into balance.” That means, Fed has less to worry on the downside, now!

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JUNE 28, 2024

Let us start with a recap of the week to June 28, 2024; and how the CME Fedwatch panned out during the week. The undertone of members was still hawkish as last mile inflation was the challenge. Here is how the CME Fedwatch chart looked in the previous week.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.3%	89.7%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	57.9%	35.9%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.2%	24.2%	50.2%	23.4%	Nil
Dec-24	Nil	Nil	Nil	Nil	1.6%	18.4%	43.4%	30.5%	6.2%	Nil
Jan-25	Nil	Nil	Nil	0.9%	11.3%	32.8%	36.0%	16.5%	2.6%	Nil
Mar-25	Nil	Nil	0.6%	7.6%	25.1%	34.8%	23.4%	7.5%	0.9%	Nil
Apr-25	Nil	0.3%	3.8%	15.6%	29.6%	29.6%	16.2%	4.5%	0.5%	Nil
Jun-25	0.2%	2.4%	10.8%	23.9%	29.6%	21.6%	9.2%	2.1%	0.2%	Nil
Jul-25	1.1%	5.4%	15.6%	26.0%	26.7%	17.1%	6.6%	1.4%	0.1%	Nil
Sep-25	5.6%	14.1%	24.5%	26.6%	18.5%	8.1%	2.2%	0.3%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers to watch out for in the week to June 28, 2024 for CME Fedwatch.

• The third and final estimate of US Q1GDP growth came in at 1.4%. It was 10 bps better than the second estimate; but sharply lower than the Q3 and Q4 GDP growth of 2024. However, this becomes a strong case of US GDP growth aligning with lower 2% inflation and lower consumer spending, paving the road for rate cuts.
• The PCE inflation figure for May 2024 came in 10 bps lower at 2.6%. Core inflation and food inflation were lower, but pressure of energy inflation continued in May 2024. That means; once the US Fed has a handle of energy inflation, then rate cuts should only be a matter of time.
• An important data point in the week was the outcome of the bank stress tests. The Fed annual bank stress tests showed that large US banks were better positioned to handle stress compared to last year. That means; the systemic banking risks we noted in early 2023, are not a challenge any longer.

The gist of the week data was that the Fed now has enough reasons to go for a rate cut in September 2024, or even attempt a pre-emptive rate cut on July 31, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO JULY 05, 2024

The latest week to July 05, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024. Interestingly, the slew of data did not have too much of an impact on the CME Fedwatch probabilities of rate cut trajectory.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.8%	92.2%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	5.9%	72.0%	22.1%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.5%	33.8%	50.9%	12.8%	Nil
Dec-24	Nil	Nil	Nil	Nil	2.0%	27.3%	47.3%	20.8%	2.7%	Nil
Jan-25	Nil	Nil	Nil	1.4%	19.3%	41.0%	29.1%	8.3%	0.8%	Nil
Mar-25	Nil	Nil	1.0%	14.0%	34.6%	32.6%	14.5%	3.1%	0.2%	Nil
Apr-25	Nil	0.5%	7.4%	24.2%	33.6%	23.6%	8.8%	1.7%	0.1%	Nil
Jun-25	0.3%	5.0%	18.4%	30.4%	27.1%	13.9%	4.1%	0.7%	Nil	Nil
Jul-25	2.2%	10.2%	23.0%	29.1%	22.0%	10.2%	2.8%	0.4%	Nil	Nil
Sep-25	10.1%	20.1%	27.7%	23.6%	12.9%	4.5%	1.0%	0.1%	Nil	Nil

Data source: CME Fedwatch

The big story of the week was the FOMC minutes published on Saturday; and that only underscored the rather ambivalent approach of the Fed.

• The minutes of the Fed meet published on July 03, 2024 was the big event of the week. The consensus was that rate cuts would be limited to just one rate cut in 2024 and possibly more aggressive in 2025. However, the FOMC members unanimously agreed that the US economy had made good progress on curtailing inflation without hitting GD growth. That is a positive takeaway, although FOMC member are on wait and watch.
• Speaking in Portugal, Fed Chair Powell made an interesting statement. According to Powell, the risk for a long time was choosing between cutting rates too soon and cutting rates too late. However, he admitted that that risk had come down, as the risk of now being too early had reduced considerably. That is good news for rate cuts.
• Crude oil inventories were the shocker of the week. As per Bloomberg estimates, the US API inventories of crude were to see a drawdown of -0.400 Million barrels in the week. However, the actual drawdown for the week was -12.157 Million barrels. That led to sharp spike in oil prices globally, as Brent scaled above $87/bbl. That is not great news for energy inflation in the US.

The big data points in the coming week will, obviously, be the CPI inflation figure and the Powell testimony to the Congress.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO JULY 12, 2024

The next week has some important triggers that will have a bearing on the CME Fedwatch. Here are some key data points for next week.

• The CPI inflation will be announced during the week on Thursday. The CPI inflation had been 3.4% in May and is likely to taper to 3.2% in June. That should be positive and also be a strong lead indicator for rate cuts. However, the focus would be more on the energy inflation component in the consumer inflation basket.
• Powell testifies before the Congress in the week on the trajectory of the monetary policy and the measures taken to rein in inflation. The Congressional testimony always assumes importance as it is under oath and is considered one of the most credible accounts of how the monetary policy is likely to shape up in the coming months.
• While other key voices like Janet Yellen, Barr and Bowman are expected to speak in the week, the important data trigger will be the movement in the crude oil inventories. After the massive drawdown of -12. 157 Million barrels last week, this week should be better, but it is still likely to be a drawdown. So, the pressure on crude prices should continue.

The big data points in the coming week will, obviously, be the Fed minutes as that will set the tone for how soon the Fed would be willing to cut rates.

CME FEDWATCH – EXPECT CAUTION IN 2024, AGGRESSION IN 2025

The latest Fed minute show that not much has changed in the Fed view, although they are now willing to bet on the fact that the economy has responded well to the interest rate triggers. PCE Inflation continues to be under 3% and that is a positive for the prospects of rate cuts by the Fed. Here is how the probabilities of different rate scenarios look like.

• With rate hikes virtually ruled out for now, we will first focus on rate cut probability in 2024. Let us first look at the rate cut possibilities in 2024. Currently, the CME Fedwatch has assigned a 78% probability that the first rate cut will happen in September; sharply higher than last week. For now, July rate cut has a probability of just about 7.8%. However, by December 2024, the CME Fedwatch is pencilling in a 76.5% probability of 2 rate cuts. Both probabilities have gone up sharply over last week.
• What about the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in an 86.6% probability of 4 rate cuts, which is quite aggressive. In addition, the CME Fedwatch is also assigning a probability of 81% probability of 5 rate cuts by September 2025. However, these probabilities are likely to evolve more realistically once the Fed embarks on its first rate cut this year.

The real question is not whether the Fed will cut rates, but whether it can afford to stay neutral for much longer? Clearly, the Fed may not want to play that game beyond September. Would the Fed really venture out and take up pre-emptive rate cuts in the July 31, 2024 Fed meet itself. At this juncture, that looks to be a very remote possibility!