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

29 Jul 2024 , 11:09 AM

SOBER ENERGY PRICES LEADS US INFLATION LOWER

A day after the US Bureau of Economic Analysis (BEA) released the first advance estimates of Q2 GDP for the US economy, they also released the PCE inflation. The PCE inflation is important for two reasons. Firstly, it is announced towards the end of the month and so it incorporates more data points compared to the consumer inflation. Secondly, the PCE (personal consumption expenditure) inflation looks at inflation from the perspective of consumption spending, which is one of the key triggers of inflation. That makes it a more actionable data point for the Fed to decide on the trajectory of interest rates.

Break-up of PCE Inflation (YOY)	Nov-23	Dec-23	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24
Headline PCE Inflation (Year on Year)	2.7	2.6	2.5	2.5	2.7	2.7	2.6	2.5
Goods	-0.1	0.2	-0.5	-0.2	0.1	0.1	-0.1	-0.2
Durable goods	-2.1	-2.3	-2.4	-2.0	-1.9	-2.2	-3.2	-2.9
Nondurable goods	1.0	1.6	0.5	0.8	1.3	1.4	1.6	1.2
Services	4.1	3.9	4.0	3.9	4.0	4.0	4.0	3.9
Addenda:
Core PCE excluding food and energy	3.2	2.9	2.9	2.8	2.8	2.8	2.6	2.6
Food	1.7	1.4	1.4	1.3	1.5	1.3	1.2	1.4
Energy goods and services	-5.0	-1.7	-4.9	-2.3	2.6	3.0	4.8	2.0

Data Source: US Bureau of Economic Analysis (BEA)

This is an item-wise break-up of how the PCE inflation has evolved over the last few months. One quick observation is that the PCE inflation has been in a tight range in 2024. While the last mile towards 2% may still take time, it looks like the upside risks are fairly limited. Here are some key takeaways.

• Headline PCE inflation, on a yoy basis, has shown a secular downward trend since April 2024. In the last two months, the inflation is down 20 bps, largely on account of slowing consumption, which was one of the pre-conditions for the Fed to cut rates.
• What about the PCE inflation for physical goods. It actually went deeper into negative from -0.1% to -0.2% in June 2024. In the first six months of 2024, the goods inflation has been in the negative for 4 out of the 5 months. Within the goods basket, the durable goods inflation has been in the negative consistently for the last 8 months, the non-durable goods inflation has been in the positive in each of these 8 months.
• For May 2024, the services inflation tapered by 10 bps from 4.0% to 3.9%. However, if you look at the last 8 months, the services PCE inflation has been consistently in a narrow range of 3.9% to 4.1%.
• Core PCE inflation yoy showed a consistent downtrend from June 2023 till February 2024; falling 150 bps from 4.3% to 2.8%. In the last 2 months, the core inflation has stagnated at 2.6% as the dividends of the post-pandemic rectification of supply chain constraints have been gradually losing steam.
• On a yoy basis, PCE food inflation is 20 bps higher at 1.4%, but is sharply down by 330 basis points from 4.7% in June 2023. The spike in food inflation could be on account of the supply shortages in the food basket, which is a global phenomenon.
• Energy inflation has literally been the core of the inflation problem in the US. This can be largely attributed to the Red Sea crisis keeping oil prices buoyant. Between January 2024 and May 2024, the PCE energy inflation has spiked by 970 basis points from -4.9% to +4.8%. However, in June 2024, the energy inflation fell sharply by 280 bps to 2.0%. Apart from fears of a Chinese slowdown, the possibility of Egypt/Qatar brokered ceasefire in the Middle East and West Asia is also pulling down the crude oil prices.

The PCE core inflation may have saturated and the headline PCE inflation may still be 50 bps short of the target. The good news is that the PCE inflation is now in a range with upside risks largely eliminated.

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

Let us start with a recap of the week to July 19, 2024; and how the CME Fedwatch panned out during the week. By the week to July 19, 2024, the markets had more or less crystallized that the first rate cut would happen by September 2024 and assigned a high probability to dual rate cuts by the end of 2024. Her are the CME Fedwatch probabilities.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	95.9%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	94.0%	1.9%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	2.4%	57.5%	39.4%	0.8%
Dec-24	Nil	Nil	Nil	Nil	Nil	2.1%	49.5%	42.0%	6.3%	0.1%
Jan-25	Nil	Nil	Nil	Nil	1.5%	36.7%	44.0%	15.9%	1.8%	Nil
Mar-25	Nil	Nil	Nil	1.1%	28.4%	42.3%	22.6%	5.2%	0.4%	Nil
Apr-25	Nil	Nil	0.6%	15.8%	35.8%	31.7%	13.2%	2.6%	0.2%	Nil
Jun-25	Nil	0.4%	10.8%	29.3%	33.1%	19.3%	6.1%	1.0%	0.1%	Nil
Jul-25	0.2%	4.9%	18.7%	30.9%	27.2%	13.6%	3.9%	0.6%	Nil	Nil
Sep-25	4.4%	16.7%	29.1%	27.7%	15.6%	5.3%	1.1%	0.1%	Nil	Nil

Data source: CME Fedwatch

The week had two important triggers which had a bearing on the CME Fedwatch probabilities.

• Speaking at the Federal Bank of Kansas City, governor Chris Waller had explicitly outlined 3 possible scenarios. While the Fed has not guided for more than one rate cut in 2024, Waller also suggested that the most likely scenario was that inflation could bounce back in the second half of 2024. Hence, the two rate cuts that the CME Fedwatch is projecting for 2024 may still be a tad optimistic.
• The drawdown on the API crude stocks continued during the week. Last week, the API crude inventories had seen drawdowns of -1.923 Million barrels, substantially higher than street estimates. In the week to July 19, 2024, the drawdowns were much higher at -4.440 Million barrels. That is likely to keep fuel inflation at elevated levels. However, there was some relief for energy inflation coming from weak Chinese demand and the prospects of a ceasefire agreement between Israel and Hamas; brokered jointly by Egypt and Qatar.

Let us now turn to the factors that had a bearing on the CME Fedwatch probabilities in the week to July 26, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO JULY 26, 2024

The latest week to July 26, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024. However, the lower than expected PCE inflation made the CME Fedwatch of two rate cuts in 2024 with a very high probability of occurrence.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	93.8%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	11.5%	88.2%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	0.2%	7.5%	60.5%	31.8%	Nil
Dec-24	Nil	Nil	Nil	Nil	0.2%	7.0%	56.9%	33.8%	2.1%	Nil
Jan-25	Nil	Nil	Nil	0.2%	5.0%	42.3%	40.5%	11.4%	0.6%	Nil
Mar-25	Nil	Nil	0.1%	4.1%	35.6%	40.8%	16.6%	2.6%	0.1%	Nil
Apr-25	Nil	0.1%	2.4%	22.4%	38.7%	26.8%	8.5%	1.1%	Nil	Nil
Jun-25	0.1%	1.7%	15.9%	33.3%	30.7%	14.5%	3.5%	0.4%	Nil	Nil
Jul-25	0.7%	7.7%	23.3%	32.2%	23.7%	9.8%	2.2%	0.2%	Nil	Nil
Sep-25	7.3%	21.1%	30.9%	25.0%	11.8%	3.3%	0.5%	Nil	Nil	Nil

Data source: CME Fedwatch

For the week to July 26, 2024, the important triggers were the first advance estimates of Q2 GDP and the PCE inflation data announced towards the end of the week.

• As is the case each time, the API crude stocks were at the centre of the CME Fedwatch probabilities. After all, the oil inventory drawdowns are one of the key factors determining fuel inflation. For the week, the API crude stocks were supposed to see lower drawdown of -2.470 Million barrels, compared to 4.440 Million barrels. However, in the current week, the actually draw down came in higher than estimates at -3,900 Million barrels. However, apart from these drawdowns, it is the ceasefire in the Middle East and the weak Chinese demand that is keeping Chinese demand for oil under stress.
• The first advance estimate of Q2GDP was put out by the US Bureau of Economic Analysis (BEA) on July 25, 2024. The Q2 advance estimate of inflation came in sharply higher at 2.8%, as compared to the final Q1 GDP figure of 1.4%. However, the Q2 GDP is still lower than the growth of 4.9% and 3.4% reported in the third and fourth quarters of 2023.
• The PCE (personal consumption expenditure) inflation was also put out by the US BEA on Friday July 26, 2024. The PCE inflation tapered by 10 bps from 2.6% to 2.5% during the week, and that is a logical corollary to the consumer inflation dipping by 30 bps in this period. The lower PCE inflation in June 2024, makes a strong base case for rate cuts in September 2024. The fall in PCE inflation in June 2024 was largely led by energy inflation tapering lower in the month.

Let us now turn to the likely triggers for the CME Fedwatch in the coming week to August 02, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO AUGUST 02, 2024

The next week has some important triggers but the focus will be on the all-important July monetary policy to be announced on the last day of the month.

• The big trigger in the coming week will be the July monetary policy of the Fed to be announced on July 31, 2024. The consensus at this point is that the Fed is unlikely to implement any rate cuts in the July meeting, although it may reiterate its intent to cut rates by 25 bps in the upcoming September meeting. There is an outside possibility that the RBI may pre-empt the situation by cutting rates in July, although there is not enough data to lac this point. The markets would be more interested in the post-market FOMC conference and the Powell statement.
• API crude stocks and non-farm payrolls will be the other key data points to watch. The API crude drawdowns were much sharper at -3.900 Million barrels in the previous week and that pressure is likely to ease. The non-farm payrolls have been around 2.30 Lakhs to 2.35 Lakhs and that is a relatively comfortable scenario to be in.
• The unemployment rate will be another factor. Last week it was at 4.1% and that is relatively higher compared to previous weeks. That is the situation that is conducive to a rate cut. The Fed would be sceptical about rate cuts only if the unemployment rate comes below 4%, which looks unlikely at this juncture.

Let us now turn to the final story of how all these flows added up to influencing the CME Fedwatch probabilities in the latest week.

CME FEDWATCH – DEAD SURE OF 2 RATE CUTS IN 2024

With the PCE inflation sobering further and the other data on jobs and GDP being conducive, the CME Fedwatch appears to be dead sure about the first rate cut happening in September and the Fed ending 2024 with 2 rate cuts. However, the real action may be in 2025. Here is a quick look at how the rate cut probabilities have panned out at the end of the current week as of July 26, 2024.

• With rate hikes virtually ruled out for now, we will focus on rate cut probability in 2024 first. Currently, the CME Fedwatch has assigned a 100% probability that the first rate cut will happen in September; higher than 98% last week. For now, July rate cut has a probability of just about 6.2%; which is insignificant. However, by December 2024, the CME Fedwatch is pencilling in a 97.9% probability of 2 rate cuts. The CME Fedwatch almost looks dead sure about two rate cuts in 2024.
• What about the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in 97.6% probability of at least 4 rate cuts, higher than the probabilities in the previous week. In addition, the CME Fedwatch is also assigning a probability of 96.2% probability of 5 rate cuts by September 2025. These probabilities will evolve more realistically once the Fed embarks on its first rate cut this year.

For now, the Fed still wants to the world to believe that it has not made up its mind on cutting rates in September. The Fed will go ahead and cut rates in September. However, it may prefer to err on the side of caution and hold for 3 months to observe data flows before deciding on the next course of action. The 2025 rate cuts may be less aggressive than what the CME Fedwatch is envisaging, but the trajectory of rates is down!