Weekly Musings – CME Fedwatch change for week to May 24, 2024

27 May 2024 , 01:31 PM

WHY FOMC MINUTES MADE MARKETS MORE HAWKISH?

Would it be appropriate to say that the FOMC minutes announced by the Fed last week has made the outlook more hawkish. That is partially true for two reasons. Firstly, the probabilities (as we shall see later) have clearly shifted to the hawkish right on the CME Fedwatch indicator matrix table. Secondly, after a long time, the likely hike in rates has got a probability assigned to it. The CME Fedwatch has cautiously priced the possibility of a rate hike of 25 bps before rate cuts actually commence. Here are 5 key takeaways from the FOMC minutes, that made the markets generally more hawkish.

• This was the first meeting in a long time that had the members discussing the possibility of a rate cut in elaborate detail. While there is still the confidence that inflation would eventually come down, the consensus is that the last mile would be a lot tougher than anticipated. Whether the talk of rate hikes is genuine or just adding a cautionary note, remains to be see. After all, such hawkish talk not only tempers market optimism on rate cuts, but it keeps inflation expectations under check too.
• The Fed underlined several times during the minutes that it will continue to use all monetary tools to keep the policy sufficiently restrictive. That is another way of saying that for the Fed and the members of the FOMC Committee, it will inflation first and inflation last. The Fed will consider labour data and GDP data to assess the future effectiveness of monetary policy. However, any chances of the Fed using lower interest rates to galvanize the economy is almost ruled out.
• As of now, there is no guidance by the Fed; either on the rates trajectory or the timing of the first rate cut. The CME Fedwatch and even Jerome Powell’s comments have pencilled a strong possibility that the first rate could happen in September this year and the US economy could see up to 2 ate cuts in this year. Therefore, it follows that the Fed meetings in June and July will only reiterate the current stance and use the interim period to analyse the data points like CPI inflation, PCE inflation and jobs carefully.
• While the markets are hinting at a September rate cuts (based on probability culled from Fed Futures trading), as of now, even the September 2024 rate cut is not a certainty. As of date, the probability of the first rate hike happening in September is just about 49%, which means there is still a 51% probability that the rates may remain at the current level or even higher by September 2024. The consumer inflation and PCE inflation numbers of May, June and July will hold the key.
• While the headline inflation on yoy basis showed some tapering traction in April 2024, the markets continue to be worried about the MOM inflation, which has shown a rising trend. The April month actually saw MOM inflation rise by 10 bps even as yoy inflation fell by 10 bps. To sum up, the Fed members still appear to lack the confidence to go ahead with a rate cut. They are wary of the negative impact of starting rate cuts too early as it could trigger a situation that would be hard to redeem.

The markets were expecting guidance on the timing and extent of rate cuts in 2024. Instead, the FOMC members have turned more hawkish, with repeated rate hike warnings, Not surprisingly, the CME Fedwatch has just turned more hawkish..

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MAY 17, 2024

The week to May 17, 2024 was marked by the CPI inflation announcement and the key speeches delivered by the FOMC members. The undertone of the members continued to be relatively hawkish as the sticky inflation has once again raised the debate over raising the rates from current levels to rapidly bring inflation under control. Here is how the CME Fedwatch chart looked ahead of the FOMC minutes being published.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.9%	91.1%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.0%	27.6%	70.4%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	14.8%	49.0%	35.2%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.4%	5.9%	26.8%	44.1%	22.8%
Dec-24	Nil	Nil	Nil	Nil	0.2%	3.4%	17.4%	36.3%	32.4%	10.3%
Jan-25	Nil	Nil	Nil	0.1%	1.5%	9.0%	24.9%	34.8%	23.6%	6.2%
Mar-25	Nil	Nil	Nil	0.8%	5.6%	17.7%	30.3%	18.7%	14.1%	2.8%
Apr-25	Nil	Nil	0.4%	2.7%	10.3%	22.7%	29.7%	22.9%	9.6%	1.7%
Jun-25	Nil	0.2%	1.6%	6.8%	16.9%	26.4%	26.1%	15.8%	5.4%	0.8%
Jul-25	0.1%	0.7%	3.6%	10.7%	20.6%	26.3%	22.1%	11.8%	3.6%	0.5%

Data source: CME Fedwatch

There were 3 critical triggers in the week to May 17, 2024 with reference to the swings in the CME Fedwatch.

• The CPI inflation or the US consumer inflation was announced during the week. Bloomberg consensus estimate had pegged the CPI inflation 10 bps lower at 3.4% and that is precisely where the actual inflation number came in. This is not likely to impress the Fed as the fall in inflation is not quick enough and it is still 140 bps away from target.
• Two major speeches during the week defined the monetary direction of the week. Powell continued to paint an optimistic picture assuring the markets that the next rate move would not be on the upside. Powell’s worst-case bet is on “Higher for Longer.” However, other members of the FOMC were not all that sanguine. Michelle Bowman, even warned that the best of inflation tapering may be done and now the upside risks were more than the downside gains. That is not great news.
• The risk of oil inflation resurfaced in the week after inventory drawdowns in the US were sharper than expected. From +0.509 Million barrels accretion last week, the oil inventories were expected to draw down by -1.350 Million barrels in the week to May 17, 2024, but actually fell by a whopping 3.104 Million barrels, raising inflation concerns.

We now turn to the key factors that triggered the shift in the CME Fedwatch in the latest week to May 24, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO MAY 24, 2024

The latest week to May 24, 2024 saw the CME Fedwatch continuing to presume just 2 rate cut in 2024; with rather volatile probabilities. However, the hawkish tone of the FOMC minutes opened up the rate hike probability too in the CME Fedwatch calculations. Here is the summary of the CME Fedwatch post the FOMC minutes.

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	Nil	99.1%	0.9%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.2%	88.9%	0.8%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	4.5%	44.9%	50.2%	0.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	1.1%	14.3%	46.2%	38.1%	0.3%
Dec-24	Nil	Nil	Nil	Nil	0.6%	8.0%	31.0%	41.9%	18.3%	0.2%
Jan-25	Nil	Nil	Nil	0.2%	3.1%	15.7%	34.6%	34.1%	12.3%	0.1%
Mar-25	Nil	Nil	0.1%	1.5%	8.7%	24.2%	34.4%	24.3%	6.8%	0.1%
Apr-25	Nil	0.4%	0.5%	3.7%	13.5%	27.4%	31.2%	18.8%	4.7%	Nil
Jun-25	Nil	0.3%	2.0%	8.4%	20.1%	29.2%	25.3%	12.1%	2.5%	Nil
Jul-25	0.1%	0.9%	4.4%	12.7%	23.4%	27.8%	20.5%	8.6%	1.6%	Nil

Data source: CME Fedwatch

There were 3 critical triggers in the week to May 24, 2024 with reference to CME Fedwatch. Here is what them meant.

• The big announcement was the FOMC minutes on May 22, 2024. For the first time, the FOMC minutes saw a detailed discussion by members on the possibility of a rate hike. Now rate hike is no longer a theoretical possibility but a likelihood to contend with. Despite the assurances from Powell that the next move would be a rate cut, the markets were far from convinced. Even CME Fedwatch is now factoring in a possible rate hike.
• Again, there were some big speeches in the week. Jerome Powell continued to hint that rate cuts were more likely than rate hikes at this juncture. However, the broad undertone of others lime Mester, Bostic, Waller and Bowman was that rate hikes were still a possibility and may even end up being the low hanging option for the Fed to address inflation quickly. Janet Yellen dwelt less on monetary policy and more on China.
• Among other data points, the initial jobless claims were pegged by Bloomberg at 220K, but came in much lower at 215K, showing strength in the US economy. In another positive for energy inflation, the API inventories came in at +1.825 Million barrels against the expectation of -2.400 Million barrels. That is likely to temper energy inflation.

Let us finally turn to the key monetary triggers in the coming week to May 31, 2024, which could have an impact on the CME Fedwatch.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO MAY 31, 2024

There are 3 critical triggers to watch out for in the coming week to May 31, 2024 with reference to CME Fedwatch.

• Monday is a holiday for US markets on account of US Memorial Day. The key focus in Fed speak this week will be the inputs coming from governors including John Williams, Michelle Bowman, Loretta Mester, and Neil Kashkari. Most of the speeches in the coming week are likely to lean towards the hawkish side, especially after the FOMC minute and the lower than expected initial jobless claims this week.
• PCE inflation data for April will be put out on May 31, 2024. Last month, the YOY PCE inflation was at 2.7% and the MOM PCE inflation was at 0.3%. The Fed has been awaiting signals that the PCE inflation is gradually retreating towards the 2% mark. Core PCE inflation is likely to inch up for April 2024.
• The other data point is the Q1-GDP second estimate that will be released on Thursday. The QOQ GDP is expected to taper sharply in the second estimate from 3.4% to 1.3%. This is likely to offer some relief for the hawks as this should tone down the persistent demand for a rate hike. The pressure on consumer spending may be starting to show.

Let us finally turn to the outlook for interest rates in the year 2024 and what the CME Fedwatch is indicating about the direction and the timing of rate cuts. We will look at the year 2024 and the first half of 2025.

CME FEDWATCH STILL PENCILS TWO RATE CUTS IN 2024

Compared to the previous week, there are 2 changes, although the expectation is still of two rate cuts in the year 2024. Firstly, the probability of rate cuts have come down sharply. Secondly, the CME Fedwatch has pencilled in the possibility of a rate hike, although it is still remove. As of date, the CME Fedwatch is pencilling in a 49% probability that the rate cuts would commence in the September 2024 Fed meet. The bet is on 2 rate cuts in 2024, but that probability is now down to just 40%. Let us look at the hawkish and dovish standpoint.

• What about the probabilities on the upside? After a fairly long gap, the probabilities on the upside are back this week. After the FOMC minutes and the hawkish tone of FOMC members, CME Fedwatch is assigning a 1% probability to a rate hike do 550-575 bps.
• What about the rate cuts on the downside. The projection still stays at 2 rate cuts in 2024, although the probability is down to just 40% now. There is a 49% probability that the first rate cut will happen in September 2024. What about 2025. By July 2025, there is a 61% probability of 3 rate cuts but just about 42% probability of 4 rate cuts. So, it looks like 4 rate cuts to the range of 4.25%-4.50% is the best case scenario by mid-2025.

The hawks in the Fed prefer to be safe than sorry, and that is justified. After being early on rate cuts can be more harmful than being late; especially when growth and spending is robust anyways. That is what is guiding Fed policy trajectory right now!