Weekly Musings – CME Fedwatch change for week to March 29, 2024

31 Mar 2024 , 10:04 AM

HOW PCE INFLATION COULD INFLUENCE FED POLICY

During the latest week to March 29, 2024, the US Bureau of Economic Analysis (BEA) announced the PCE inflation. The US announces two inflations; the consumer inflation is announced towards the middle of the month while the PCE inflation based on personal consumption expenditure is announced towards the end of the month. It is the PCE inflation that is normally used as the barometer by the Fed for its rate decisions. This data is presented below is on yoy basis.

Break-up of PCE Inflation (YOY)	Jul-23	Aug-23	Sep-23	Oct-23	Nov-23	Dec-23	Jan-24	Feb-24
Headline PCE Inflation (Year on Year)	3.3	3.3	3.4	2.9	2.7	2.6	2.4	2.5
Goods	-0.2	0.7	0.9	0.2	-0.1	0.2	-0.5	-0.2
Durable goods	-1.0	-1.9	-2.3	-2.2	-2.1	-2.3	-2.4	-2.0
Nondurable goods	0.2	2.1	2.7	1.6	1.0	1.6	0.5	0.8
Services	5.1	4.7	4.6	4.3	4.1	3.9	3.9	3.8
Addenda:
Core PCE excluding food and energy	4.2	3.7	3.6	3.4	3.2	2.9	2.9	2.8
Food	3.7	3.1	2.7	2.4	1.7	1.4	1.4	1.3
Energy goods and services	-13.0	-3.5	0.1	-4.6	-5.0	-1.7	-4.9	-2.3

Data Source: US Bureau of Economic Analysis (BEA)

To get a better perspective of the YOY PCE inflation for February 2024, we look at the break-up of the inflation at 2 levels. We first break up the PCE inflation into goods and services to pinpoint the triggers. Then we break up the PCE inflation based on the basket composition; food, energy, and core inflation. Here are key takeaway and what it means for rate cuts.

• While the trend of headline PCE inflation has been consistently lower, the latest month saw a 10 bps spike, which takes the PCE inflation about 50 bps away from the long term target. That is likely to limit the Fed’s leeway on rate cuts.
• PCE inflation for durable goods hardened from -2.4% to -2.0%, while the PCE inflation for non-durable goods also hardened from 0.5% to 0.8%. It looks like the low input cost cycle is breaking and that is likely to make the Fed cautious about rate cuts.
• The good news is that services inflation, which caused most of the spike in inflation since late 2021, has shown signs of peaking. For February 2024, the services inflation tapered by 10 bps to 3.8%; but the services inflation is down a full 180 basis points from a high of 5.6% in April 2023.
• In the PCE inflation basket composition, Core PCE inflation fell 10 bps to 2.5% in February 2024, while the PCE food inflation also tapered by 10 bps to 1.3%. While the long term trend is down, the MOM number shows pressure on these items.
• The villain of the piece was undoubtedly energy inflation, which hardened sharply in the month of February 2024 from -4.9% to -2.3%. Inflation is still negative but that is more due to the high base effect. For the Fed, the energy inflation remains the joker in the pack and till the Red Sea crisis subsides, the Fed may wait and watch.

While the first rate cuts are only scheduled after June 2023, the latest week data on PCE inflation indicates that the decision to cut rates may be more complicated for the Fed. The CME Fedwatch is reflecting this heightened ambiguity on rate cuts.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MARCH 22, 2024

After the consumer inflation came in higher for the week to March 15, 2024, the week to March 22 saw the all-important Fed statement. The Fed, in its statement, had hinted that 3 rate hikes would happen in 2024, even if back-ended. The CME Fedwatch had then stuck to its view of 3 rate hikes in 2024 and 5 rate hikes by mid-2025.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	12.4%	87.6%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.9%	66.5%	24.5%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	4.4%	37.5%	45.7%	12.7%
Sep-24	Nil	Nil	Nil	Nil	Nil	3.5%	30.2%	43.9%	19.7%	2.7%
Nov-24	Nil	Nil	Nil	Nil	1.7%	17.0%	37.2%	31.6%	11.1%	1.3%
Dec-24	Nil	Nil	Nil	1.2%	12.3%	31.0%	33.3%	17.4%	4.3%	0.4%
Jan-25	Nil	Nil	0.6%	6.9%	21.8%	32.2%	25.2%	10.7%	2.3%	0.2%
Mar-25	Nil	0.3%	4.1%	15.2%	27.6%	28.3%	17.2%	6.1%	1.1%	0.1%
Apr-25	0.1%	1.9%	8.8%	20.5%	27.9%	23.5%	12.5%	4.0%	0.7%	0.1%
Jun-25	1.2%	5.4%	14.7%	24.2%	25.7%	17.9%	8.1%	2.3%	0.4%	Nil

Data source: CME Fedwatch

There were 3 critical drivers in the week to March 22, 2024 with reference to movements in the CME Fedwatch.

• The big trigger for the week was the FOMC policy statement on March 20, 2024, which held the Fed rates in the range of 5.25% to 5.50%. That was expected. The big positive was the Fed statement, where Jerome Powell signalled 3 rate cuts in year 2024.
• Along with the Fed policy statement, the FOMC had also put out updated projections for next 3 years; and the long term median picture. While the GDP projections for 2024 were upped by 70 bps, unemployment was held static while the projection for core PCE inflation has been raised for 2024. The message was that rate cuts would be slower.
• API weekly crude stocks were expected increase by 0.077 Million barrels, but instead fell by -1.519 Million barrels. That also put pressure on oil prices. For Q4, the US reported sharply lower current account deficit, and that has pushed up the value of the dollar int the global currency markets. The Fed bond book tapering slowed, as hinted by FOMC.

Let us now move the big drivers from the US markets for the current week to March 29, 2024; which had a deep impact on the shifts in CME Fedwatch.

CME FEDWATCH IN LATEST WEEK TO MARCH 29, 2024

The latest week to March 29, 2024 saw the CME Fedwatch get less dovish. In contrast to the enthusiasm created last week by the Fed statement and the Powell assurance of rate cuts, this week saw hawkish data from the Q4 GDP and from PCE inflation for February 2024. The table below captures Fed Futures probabilities over next 10 FOMC meetings. The expectation is a maximum of 75 bps rate cut by December 2024. However, the CME Fedwatch now veering towards the possibility that the Fed may stop at 50 bps in 2024.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.2%	95.8%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.6%	61.0%	36.4%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	25.5%	51.3%	22.1%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	3.5%	28.1%	48.4%	19.9%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.7%	7.5%	31.4%	43.7%	16.6%
Dec-24	Nil	Nil	Nil	0.5%	5.4%	24.2%	40.0%	24.9%	5.0%	Nil
Jan-25	Nil	Nil	0.2%	2.5%	13.1%	30.7%	33.8%	16.7%	3.0%	Nil
Mar-25	Nil	0.1%	1.5%	8.7%	23.4%	32.5%	23.8%	8.7%	1.2%	Nil
Apr-25	0.1%	0.7%	4.5%	14.8%	27.2%	28.9%	17.5%	5.6%	0.7%	Nil
Jun-25	0.4%	2.7%	9.8%	21.2%	28.1%	23.0%	11.4%	3.1%	0.4%	Nil

Data source: CME Fedwatch

There were 3 critical triggers in the latest week to March 29, 2024 with reference to CME Fedwatch.

• The third and final estimate of US Q4 GDP came in much better than expected at 3.4%, which is 20 bps better than the second estimate. What is more interesting is that the surge was driven by nominal GDP growth. That kind of growth is not consistent with the situation that the Fed would like if it has to cut rates.
• The PCE inflation number for February 2024 came in 10 bps higher at 2.5%. While food and core inflation were 10 bps lower over last month, the pressure came from energy inflation. The Red Sea crisis was having its impact on the energy prices. Clearly, this is likely to make the Fed cautious about cutting rates too quickly.
• There were two major speeches in the week. Christopher Waller continued to reiterate that it was too early to cut rates and the Fed should take more time and visit more data points. On Friday, Powell only hinted that he wanted to avoid disruptive quantitative tightening, but did not mention about the timetable of rate cuts.

Let us now turn to what could be the major triggers for the CME Fedwatch in the coming week to April 05, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO APRIL 05, 2024

There are 4 critical triggers to watch out for in the coming week to April 05, 2024 with reference to CME Fedwatch.

• There is the all-important meeting of the OPEC coming up in the coming week and the OPEC could take a call on further cuts in supply. For now, the market is already undersupplied amidst robust oil demand and US inventories are under pressure. That has kept oil prices up and energy inflation is the problem.
• There are s series of Fed speeches in the coming week. Last week, Waller and Powell gave broad hints that rates may time to come down. This week, Bostic, Williams, and Bowman are slated to speak. Michelle Bowman is a known hawk and has been against the Fed cutting rates in a hurry.
• February factor orders will be the first official confirmation that there is visible improvement in the manufacturing sector. In January MOM factory orders contracted by -3.6%, but in February 2024, it is expected to show positive growth of 1.0%. That will be a strong leading indicator of future manufacturing GDP growth.
• Among other data points, the dollar index will be closely tracked by the CME Fedwatch, as it continues to harden against currencies like the Euro and the Pound. The Atlanta Fed GDP for Q1 is expected to come in at 2.1%, which is not surprising after the robust 2.5% GDP growth reported for full year 2023.

Let us finally turn to how the CME Fedwatch has not only converged with the Fed viewpoint, but CME Fedwatch has become sharply less dovish.

CME FEDWATCH GETS LESS DOVISH POST US DATA FLOWS

The last 3 weeks have been a see-saw. In the week to March 15, 2022, the higher consumer inflation resulted in hawkishness. However, that was offset by the dovish language adopted by Jerome Powell in the Fed statement. In the latest week to March 29, 2024, the PCE inflation also came in 10 bps higher while the GDP growth for Q4 came in at a robust 3.4% based on final estimates. The combination is clearly a recipe for the Fed to go slow on rate cuts. After all, why should the Fed press the button on rate cuts, when GDP was so robust?

• On the upside, there is consensus between the Fed and the CME Fedwatch that rates have peaked at 5.25%-5.50%. That is something CME Fedwatch has been hinting for some time. Fed may, at best, choose to hold rates higher for longer; but rate hikes were off the table. Especially, with Powell mentioning in his speech that he wanted to avoid disruptive quantitative tightening at all costs.
• On the downside, there is not only sync between the CME Fedwatch and the Fed viewpoint, but the CME Fedwatch looks less dovish than the Fed. In the Fed statement, Jerome Powell, gave a signal that Fed would go ahead with 3 rate cuts in 2024. That did not change the expectations of the CME Fedwatch on the extent of rate cuts, but it certainly made some of the probabilities on the downside more intense. This week, the scenario changed after the PCE inflation and GDP data. Now, CME Fedwatch is expecting maximum 3 rate cuts in 2024, with a 50% probability that the Fed restricts to just 2 cuts.

What can we decipher from the language of the Fed statement and the shifts in the CME Fedwatch? Fed has underscored that last mile inflation could be the toughest to handle and the CME Fedwatch is taking that seriously. The Fed chair may have been a little early in assuring 3 rate cuts in 2024. The data and the speeches this week by Fed governors, don’t seem to align with the relative dovish assurance of Jerome Powell.