Weekly Musings – CME Fedwatch change for week to March 15, 2024

18 Mar 2024 , 07:28 AM

US INFLATION READING RULES OUT RATE CUTS IN FIRST HALF OF 2024

In the latest week, the Bureau of Labour Statistics (BLS) announced the consumer inflation for the US economy for February 2024. This is the precursor for the PCE inflation, based on personal consumption expenditure, that is announced in the last week of the month. This time around, the consumer inflation came in 10 bps higher at 3.2%. However, there were 4 key reasons why the Fed may not consider rate cuts in H1-2024.

• The last mile, as Jerome Powell projected is turning out to be much tougher than expected. For instance, in January 2024, the inflation estimate had been pegged at 2.9%, but it came in at 3.1%, a full 20 bps higher. In February 2024, the consumer inflation has come in 10 bps higher than estimated at 3.2%. This is likely to make Fed wary of any rate cuts for now.
• As members of the Fed have been saying in recent speeches post the last policy, there is really no hurry to go ahead with the rate cuts. That is because, the labour situation is well in control and the GDP growth also stays robust. In these conditions, there is no specific reason for the Fed to go ahead and cut rates right away. Fed has the luxury for waiting for some more time and it would prefer to do that.
• The Red Sea crisis has made the Fed cautious. If you look at the break-up of the consumer inflation in the last 2 months, most of the pressure has come from the oil basket due to the Red Sea crisis. What is interesting is that the even the pressure on the core inflation in the latest month comes from fuel related items like airline fares, car maintenance etc. Obviously, the Fed wants to avoid the magnifying effect, since once rates are cut, it would be very difficult to reverse the decision, should inflation go up.
• The Fed not only looks at the yoy inflation but also at the high frequency MOM inflation. For February, the MOM inflation has shot up to 0.4%, with the high frequency energy inflation at 2.3%. That is where most of the pressure on the consumer inflation is coming from. This is despite the MOM food inflation falling sharply to 0.0% in February 2024.

With too many uncertainties at this point of time, the Fed has not incentive to hike the rates on an urgent basis. It can afford to wait and watch as it has the luxury of better than expected GDP and labour data. Also, the inflation target is a good 110 bps away and the Fed would want more clarity on the inflation journey towards 2%.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MARCH 08, 2024

For the week to March 08, the big data flows were the Powell testimony in front of the US Congress and other data pertaining to Fed speak and the Fed balance sheet. The table captures the CME Fedwatch data at the close of March 08, 2024, hinting at about 75 to 100 bps rate cut in the year 2024.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.0%	96.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.6%	18.0%	81.4%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	0.3%	10.2%	52.8%	36.7%
Jul-24	Nil	Nil	Nil	Nil	Nil	0.2%	6.0%	34.8%	43.5%	15.5%
Sep-24	Nil	Nil	Nil	Nil	0.1%	4.4%	26.8%	41.1%	23.3%	4.3%
Nov-24	Nil	Nil	Nil	0.1%	2.4%	16.5%	34.5%	31.5%	13.1%	2.0%
Dec-24	Nil	Nil	Nil	1.6%	11.8%	28.4%	32.5%	19.2%	5.7%	0.7%
Jan-25	Nil	Nil	1.0%	7.5%	21.4%	30.8%	24.9%	11.4%	2.8%	0.3%
Mar-25	Nil	0.4%	3.6%	13.2%	25.2%	28.3%	19.3%	7.9%	1.8%	0.2%
Apr-25	0.3%	2.4%	9.6%	20.8%	27.2%	22.7%	12.1%	4.0%	0.8%	0.1%

Data source: CME Fedwatch

There were 3 critical triggers in the week to March 08, 2024 with reference to CME Fedwatch.

• There was the all-important Fed testimony on February 06th in front of the Senate Banking Committee. In this testimony, Jerome Powell underlined that rate cuts would entirely be a function of inflation explicitly trending towards the 2% mark. However, Jerome Powell also made a significant remark that he saw a number of rate hikes in 2024, which meant inflation moves should be favourable in the year 2024.
• The Fed balance sheet was in focus after the Fed had hinted in its last policy statement that it may look to go slow on the Fed book taper so that liquidity tightness does not become a challenge for the US economy. The bond book had tapered to $7.568 Trillion in the previous week. According to the hints in the Fed statement, the Fed bond book only tapered marginally to $7.539 Trillion in the week to March 08, 2024.
• In terms of Fed speak this week, Adriana Kugler spoke at length on the dual mandate that the Fed has been grappling with. According to Kugler, Fed had to contain inflation without impacting the labour market or impacting GDP. The moral of the story was that the Fed had largely succeeded in containing inflation without risking a hard landing.

Let us now turn to the key triggers for the CME Fedwatch in the latest week to March 15, 2024 and its implications for the CME Fedwatch.

CME FEDWATCH IN THE WEEK TO MARCH 15, 2024

The latest week to March 15, 2024 was all about the CPI inflation and the consumer inflation expectations as the key triggers for the CME Fedwatch. The table below captures the Fed Futures probabilities over the next 10 meetings of the Federal Open Markets Committee (FOMC) at the close of the week. The expectation is a maximum of 75 bps rate cut by December 2024 and a total of 100 to 125 bps by April 2025. The first rate cut is seen as more likely in July 2024 only.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.0%	98.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	6.4%	93.6%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	3.6%	55.2%	41.2%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	1.7%	27.1%	48.8%	22.4%
Sep-24	Nil	Nil	Nil	Nil	Nil	1.2%	19.4%	42.3%	30.4%	6.7%
Nov-24	Nil	Nil	Nil	Nil	0.6	10.1%	30.7%	36.4%	18.8%	3.4%
Dec-24	Nil	Nil	Nil	0.4%	6.7%	23.3%	34.3%	25.1%	9.0%	1.2%
Jan-25	Nil	Nil	0.2%	3.6%	15.1%	28.9%	29.7%	16.9%	5.0%	0.6%
Mar-25	Nil	0.1%	2.0%	9.7%	22.4%	29.3%	23.0%	10.7%	2.7%	0.3%
Apr-25	Nil	1.0%	5.5%	15.4%	25.5%	26.4%	17.4%	7.0%	1.6%	0.2%

Data source: CME Fedwatch

There were 3 critical triggers to track in the week to March 15, 2024 with reference to CME Fedwatch.

• The big trigger of the week was the CPI inflation for February, which came in 10 bps higher at 3.20%. While food inflation was 40 bps lower and core inflation fell 10 bps, there was a sharp spike in oil inflation, which pushed up the headline consumer inflation by 10 bps. This is likely to make the Fed wary of rate cuts in the first half of 2024.
• Another important data point this week was the Consumer inflation expectations announced on Monday. Here, the actual number at 3.0% was exactly at what the markets had estimated. Consumer inflation is something the markets would eventually like to see at a much lower level.
• The OPEC monthly and the IEA report were released in the week. The common thread appears to be that the mini recession in the UK and Japan was unlikely to impact the demand for oil too much. Also, the expectation is that the oil market will remain undersupplied in the current month, pushing Brent prices closer to $90/bbl.

Let us finally turn the key triggers for the CME Fedwatch in the coming week to March 22, 2024.

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO MARCH 22, 2024

There are 3 critical triggers to watch out for in the coming week to March 22, 2024 with reference to CME Fedwatch.

• The big trigger for the week will be the FOMC policy statement on March 20, 2024. The Fed is expected to hold the rates at the current range of 5.25% to 5.50% and that is what even the CME Fedwatch is expecting. However, the market will be looking for triggers in the form of guidance on when the rate cuts could commence.
• Along with the Fed policy statement, the FOMC will also put out the updated projections for the next 4 years. The March quarterly update is expected to upgrade the GDP projections for 2024 while the real area of interest would be what happens to the rate of unemployment expectations and the rate inflation trajectory for the coming years.
• Among other data points, the quarterly Atlanta GDP estimates will be out this week and is expected at 2.3% for Q1-2025. On the API oil inventory front, there was a drawdown of 5.52 Million barrels last week and amidst the Red Sea crisis we could see the situation repeat this week also. That is likely to trigger energy inflation in the US.

Let us finally turn to how the CME Fedwatch has not only converged with the Fed viewpoint, but CME Fedwatch is becoming more hawkish than the Fed itself.

CME FEDWATCH NOW MORE HAWKISH THAN FED STANCE

In the previous week, the Powell testimony had made the CME  Fedwatch slightly dovish due to the hints of rate cuts happening. However, this week, the higher than expected consumer inflation at 3.2% played the spoilsport. Now, the CME Fedwatch is not only pegging rate cuts at 75 bps in 2024, but it is also hinting at a substantial possibility that the Fed may restrict itself to just 50 bps of rate cuts in the calendar 2024. Here is a dekko.

• On the upside, there appears to be virtual consensus between the Fed and the CME Fedwatch on rates trajectory. The Fed has committed that the rates may have peaked at 5.25%-5.50%. The same was reiterated by Jerome Powell in the Congress testimony, while the latest month inflation is also just mildly higher. The Fed minutes have already averred that the probability of rate cuts was substantially higher than the probability of rate hikes at this juncture. Apparently, additional rate hikes will only happen in a worst case scenario, not otherwise. However, Fed may choose to hold rates higher for longer. The Fed and the CME Fedwatch are almost entirely in sync on the upside; although the CME Fedwatch assigns a high probability to rates at above 5% right up to September.
• On the downside, there is not only substantial sync, but the CME Fedwatch may not be getting more hawkish than the Fed. The aggression of the CME Fedwatch had been toning down in recent weeks as the divergence was closing in. Last week, after the Powell testimony to the Congress, there was some divergence seen as the CME Fedwatch started to get a little optimistic about the pace of rate cuts. However, that enthusiasm was dampened in the current week after the US consumer inflation for February 2024 came in 10 bps higher at 3.2%. The original estimates of the Fed were at around 75 bps rate cut in 2024 and another 100 bps in 2025. As of date, the Fed has not yet changed its stance on rate cuts, but the CME Fedwatch is already factoring in a higher probability that the rate cuts in 2024 could be just about 50 bps instead of 75 bps. In that sense, the CME Fedwatch has not turned less dovish than the Fed.

In the past, the Fed has underscored that last mile inflation was the toughest to handle, although the Fed appears confident that it should happen in 2024. In recent weeks, the Fed speak has been broadly hinting at why the rates may not be cut in a hurry. The Red Sea crisis has caused oil inflation to spike and that is likely to keep the consumer inflation and the PCE inflation higher. One thing is crystal clear; the Fed would be purely data driven.