Weekly Musings – CME Fedwatch change for week to June 14, 2024

18 Jun 2024 , 09:32 AM

FED MACRO PROJECTIONS HINT AT HIGHER FOR LONGER

The Fed policy did not make any changes to its rates, but it reduced the guidance for rate cuts to just one rate cut in 2024. In addition, we now also have the June updates of key macros and these projections exactly match with the Fed guiding for just 1 rate cut in 2024. However, rate cuts could be more aggressive in 2025. The table below captures the gist of FOMC macro projections for next 3 years, as updated with June 2024 data.

Variable	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Jun-24)	2.10	2.00	2.00	1.80
March-2024 projection	2.10	2.00	2.00	1.80
Unemployment rate (Jun-24)	4.00	4.20	4.10	4.20
March-2024 projection	4.00	4.10	4.00	4.10
PCE inflation (Jun-24)	2.60	2.30	2.00	2.00
March-2024 projection	2.40	2.20	2.00	2.00
Core PCE inflation (Jun-24)	2.80	2.30	2.00
March-2024 projection	2.60	2.20	2.00
Federal funds rate (Jun-24)	5.10	4.10	3.10	2.80
March-2024 projection	4.60	3.60	3.10	2.60

Data Source: US Federal Reserve (CY refers to calendar year)

Here are some of the key takeaways from the FOMC long term projections updated as of the June 2024 quarter; with comparisons with the March 2024 projections.

• To begin with, there is not much of change in the GDP projections. For CY2024, the real GDP is expected to grow by 2.1%; exactly as per the March estimates. It is expected to stabilize at 2.00% for next two years and then at 1.80% in the long run. The GDP euphoria of Q3-2023 and Q4-2023 has sobered due to deliberate compression in GDP with the help of rate hikes, something that the Fed actually wanted.
• The changes in the job situation (unemployment) are marginal. For CY2024, the unemployment rate is expected at 4.0%; as in March projections. However, for 2025 and 2026 have been raised by 10 bps from March 2024 projections. So, unemployment is going to be a good 60 bps to 70 bps above full employment, reducing the pressure on wages and persistent spending. That should help tame inflation.
• Let us turn to the all-important inflation reading. Fed expects pressure in CY2024 and CY2025, but prices should stabilize after that. PCE inflation estimates for CY2024 have been raised by 20 bps in June to 2.6% and by 10 bps for CY2023 to 2.3%. That means; till the end of 2025, the 2% inflation target will continue to be elusive. The pressure from rate cuts and the Red Sea crisis should keep inflation at higher levels for longer. More importantly, the core inflation pressure is expected in CY2024 and CY2025.
• How does this impact rate projections? For 2024 year-end, interest rate estimates are upped 50 bps to 5.1%. However, rates should sober to 4.1% by the end of 2025. Even the long run interest rates are pegged 20 bps higher at 2.8% against the March estimate of 2.6% long term inflation. So, we could see a good 4-5 rate cuts in 2025, subject to the inflation data being supportive.

The moral of the story is that the last mile inflation will remain sticky, so the rates are going to stay at higher levels for a longer period than originally envisaged.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JUNE 07, 2024

Let us start with a recap of the week to June 07, 2024; and how the CME Fedwatch panned out during the week. The undertone of the members continues to be hawkish as the last mile inflation remains sticky. Hence, higher for longer, is the theme for now. Here is how the CME Fedwatch chart looked ahead of the FOMC meeting and the quarterly projections.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.24%	97.8%	Nil
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	8.1%	91.8%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	3.8%	46.6%	49.5%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	1.1%	15.9%	47.4%	35.6%	Nil
Dec-24	Nil	Nil	Nil	Nil	0.7%	10.2%	35.3%	40.1%	13.7%	Nil
Jan-25	Nil	Nil	Nil	0.3%	4.9%	21.3%	37.4%	28.4%	7.6%	Nil
Mar-25	Nil	Nil	0.2%	2.7%	13.6%	29.8%	32.7%	17.4%	3.6%	Nil
Apr-25	Nil	0.1%	1.1%	6.5%	19.3%	30.8%	27.3%	12.6%	2.3%	Nil
Jun-25	Nil	0.6%	4.0%	13.4%	25.5%	28.9%	19.4%	7.1%	1.1%	Nil
Jul-25	0.3%	1.9%	7.6%	18.0%	26.8%	25.3%	14.7%	4.8%	0.7%	Nil

Data source: CME Fedwatch

There were 3 critical triggers to watch out for in the week to June 07, 2024 with reference to CME Fedwatch.

• One of the most important factor impacting the CME Fedwatch during that week was the jobs data, which came in nearly 40% higher than estimate at 2,72,000 jobs. What did that mean? Remember, robust jobs growth in non-farm payrolls was combined with wage growth of over 4.1%. Such strong jobs numbers and robust wage growth are a clear indication that the time may not be ripe for rate cuts.
• The Atlanta Fed estimate for Q2 GDP for the week, came in sharply lower at 1.6%, compared to the street estimate of 2.7%. This is broadly in line with the first quarter GDP estimates, where the final estimate is still awaited. This is actually supportive of lower long term inflation and could make a case for rate cuts.
• The crude oil inventories reported by API had seen heavy drawdown of -4.156 Million Barrels in the week to May 31, 2024. In the week to June 07, 2924, crude oil inventories were supposed to see a drawdown of -2.100 million barrels. However, there actually was an accretion of +1.233 million barrels. This is likely to keep energy inflation in check, which is positive for taming inflation.

For now, the last mile inflation is not giving clear signals. The CME Fedwatch has reconciled to the first rate cuts happening on in September; although it will still be an inflation game.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO JUNE 14, 2024

The latest week to June 14, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024. However, this is despite the Fed now guiding for just one rate cut in 2024.

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	6.6%	61.1%	32.3%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.6%	28.2%	49.7%	19.5%	Nil
Dec-24	Nil	Nil	Nil	Nil	2.1%	23.2%	45.5%	25.4%	3.8%	Nil
Jan-25	Nil	Nil	Nil	1.3%	14.7%	36.6%	33.5%	12.5%	1.5%	Nil
Mar-25	Nil	Nil	0.9%	10.5%	29.7%	34.4%	19.1%	5.0%	0.5%	Nil
Apr-25	Nil	0.4%	5.4%	19.6%	31.9%	27.1%	12.4%	2.8%	0.3%	Nil
Jun-25	0.3%	3.6%	14.4%	27.4%	28.9%	17.8%	6.3%	1.2%	0.1%	Nil
Jul-25	1.7%	8.0%	19.7%	28.0%	24.4%	13.1%	4.2%	0.7%	0.1%	Nil
Sep-25	7.2%	16.0%	25.4%	25.5%	16.7%	7.0%	1.8%	0.3%	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers influencing the CME Fedwatch in the week to June 14, 2024; and all of them were very critical inputs.

• The US Fed released its June monetary policy on June 12, 2024. The monetary policy statement was supposed to be a tepid affair with rates constant. While rates were held at 5.25%-5.50%, there was a lot of cues. The Fed reduces the rate cut guidance to just 1 rate cut in 2024, but committed to more aggressive rate cuts in 2025. That has gone down well with the markets and is reflected in the CME Fedwatch.
• The all-important CPI inflation in the US for May 2024 was also announced this week. While the core inflation and food inflation tapered, the pressure came from a sharp spike in the energy inflation. Energy products and energy services saw a sharp spike in inflation. However, thanks to food and core baskets, the overall inflation tapered by 10 bps to 3.3% for the month of May 2024.
• Like the Fed does every 3 months, the quarterly update for key macros was also updated. Compared to the last update in March 2024, the June update has pegged higher levels of core inflation and headline inflation in future years, but has kept GDP growth and unemployment projections approximately flat. Rates are expected to be higher for longer. It will be 50 bps higher at 5.1% as of end-2024 and up 20 bps at 2.8% in the long run rate estimates.

Inflation is sticky in the last mile and rates are likely to be higher for longer. However, the CME Fedwatch is pencilling in aggressive rate cuts in 2025.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO JUNE 21, 2024

It will be a truncated week in the US with June 19, 2024 being a holiday. There are 3 critical triggers to watch out for in the coming week to June 21, 2024 for CME Fedwatch.

• Key FOMC members like Williams and Harker are expected to be speaking in this week. The markets will be closely tracking their speeches to gather cues on when the first rate cut will be taken up by the Fed and how rate cuts will evolve in the year 2025.
• The API crude weekly stocks will be the key to energy inflation, especially since that is the component that is holding up US inflation at elevated levels. Last week, the API reserves saw a drawdown of -2.428 Million barrels. Another week of drawdown in oil reserves will put further pressure on oil prices and on energy inflation.
• On Friday, the Monetary Policy Report will be submitted to the Congress about the conduct of monetary policy and the key discussion points. This will be followed by Jerome Powell deposing before the Senate Banking Committee under oath; so, it carries a lot of value in terms of deciphering the actual intent of the Fed policy.

There are no key data points or events next week, so the action shifts to what the members of the FOMC speak at various fora. Powell will have to face some tough question in front of the Congress since rate cuts have not happened as originally guided.

CME FEDWATCH EXPECTS CAUTIOUS 2024; AGGRESSIVE 2025

Based on the latest flows, how have the probabilities of rate cuts changed in the week. During the week, the big data announcements were the consumer inflation numbers for May, the Fed policy statement by the FOMC and the long term macro projections updated for the June 2024 quarter. Let us look at the hawkish and dovish standpoint.

• What about the probabilities on the upside? After a brief indication of rate hikes, the CME Fedwatch is back to pencilling in no rate hikes. Even in the latest policy statement, Powell underlined that he did not foresee rate hikes, unless there was a serious black swan kind of situation. That looks like a remote possibility for now.
• What about the downside. Let us first look at the rate cut possibilities in 2024. Currently, the CME Fedwatch has assigned a 68% probability that the first rate cut will happen in September. However, by December 2024, the CME Fedwatch is pencilling in a 71% probability of two rate cuts, which is in contrast to the Fed guidance of just one cut.
• What about the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in an 82% probability of overall 4 rate cuts, which his quite aggressive. In addition, the CME Fedwatch is also assigning a probability of 74% probability of 5 rate cuts by September 2025. However, these stories will evolve better only after the actual rate cut start. The bottom line is that the CME Fedwatch is expecting that even if the Fed restricts itself to just 1 rate cut in 2024, it will compensate through greater aggression in 2025. That was also the tone of the Fed statement.

At the end of the day, it will depend on whether the hawks within the Fed get the upper hand or the doves get the upper hand; but for now, the CME Fedwatch is being more realistic. A lot more clarity on the trajectory of rates will be there after the Fed chair, Jerome Powell deposes before the Congress in the coming days.