Weekly Musings – CME Fedwatch change for week to May 31, 2024

4 Jun 2024 , 10:13 AM

DOES WEAK GDP PAVE THE WAY FOR US RATE CUTS?

Normally, the story with GDP growth is that, the higher the better. However, in the US, it works both ways. Higher GDP is good, but it also means that the Fed is unlikely to cut rates till the GDP justified rate cuts. Also, high GDP means robust purchasing power, which would anyways neutralize any hawkishness. In such cases, the rate cuts are not needed. The second estimate of Q1-GDP in the US has come in 30 bps lower than the first advance estimate, at 1.3%. That has again raised calls for the Fed to cut rates in a pre-emptive manner. The second estimate at 1.3% for Q1 was 30 bps lower than 1.6% in the first estimate but sharply lower than 4.9% and 3.4% in Q3-2023 and Q4-2024 respectively. Here is a quick look at the data.

GDP Data	Q4-2022 YOY (%)	Q1-2023 YOY (%)	Q2-2023 YOY (%)	Q3-2023 YOY (%)	Q4-2023 YOY (%)	Q1-2024 YOY (%) #
GDP Overall	2.6	2.2	2.1	4.9	3.4	1.3
GDP – Goods	6.2	-1.3	0.9	7.3	2.6	-3.5
GDP-Services	2.5	3.2	1.9	2.9	2.8	2.8
Structures	-9.6	8.9	7.7	10.0	10.4	7.9
Auto O/P	-1.2	14.7	15.4	-7.1	-21.8	-7.4
GDP Ex-Auto	2.7	1.9	1.7	5.2	4.2	1.5
Non-farm GVA	2.8	1.8	2.0	5.8	3.8	0.9

Data Source: US Bureau of Economic Analysis (BEA) – # Second Estimates

Is the Q1 GDP second estimate, actually lower or is it just a cyclical phenomenon. Here is a quick evaluation of what caused this fall in GDP estimates.

• Let us first look at the physical goods or the merchandise GDP for the US economy. The growth in GDP for physical goods fell into negative at -3.5% in Q1-2024; which is 110 bps lower than the first estimate. In the last two sequential quarters, this figure had been +7.3% and +2.6%. The demand compression could be a direct outcome of geopolitical risks and monetary tightness.
• GDP Services continued to be in the positive as it witnessed limited global impact. However, it must be noted here that the GDP Services for Q1-2024 was lowered in the second estimate by 20 bps from 3.0% to 2.8%; which looks more at par with the previous 2 sequential quarters.
• The auto output continues to be negative, putting pressure on overall manufacturing output. The weak auto demand has been an outcome of pressure on household budgets and also due to higher cost of funding amidst elevated rates of interest in the US economy. In the first estimate of Q1 GDP, auto output contracted by -6.4%; which has deepened to -7.1% in the second estimate. GDP ex-auto continues to be tepid and has been lowered by 30 bps from 1.8% to 1.5% in the second estimate of Q1 GDP.
• Finally, we come to the non-farm GVA (gross value added), which was lower at 1.3% in Q1-2024 in the first estimate, and has been lowered to 0.9% in the second estimate. The pressure is once again coming from the geopolitical and trade impact on output.

Let us now turn to how the CME Fedwatch panned out in the week to May 24, 2024.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MAY 24, 2024

The week to May 24, 2024 was marked by the minutes of the FOMC and the key speeches by the FOMC members. The undertone of the members continued to be relatively hawkish as the inflation continues to be sticky, making a strong case to persist with the “higher for longer approach.” Here is how the CME Fedwatch chart looked ahead of the FOMC minutes being published.

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 they implied.

• The big announcement during the week was the FOMC minutes published by the US Federal Reserve on May 22, 2024. Interestingly, this was the first time that the FOMC minutes saw an elaborate discussion by members on the possibility and the wisdom of a rate hike at this juncture to step further inflation stickiness. Despite the assurances from Powell that the next move would be a rate cut, the CME Fedwatch started factoring in a low probability of a rate hike by 25 bps in the months to come.
• There were some big speeches in the week. Jerome Powell has been more moderate and has continued to hint that rate cuts were more likely than rate hikes at this juncture. However, markets are not really buying into that argument. However, the broad undertone of others like 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. It remains to be seen if Fed will take the risk of just plumping for the long hanging fruit and raise rates to curtail inflation.
• 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 expected -2.400 Million barrels. Higher API inventories are likely to temper energy inflation.

Let us now turn to the key factors that triggered changes in the CME Fedwatch in the week to May 31, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO MAY 31, 2024

The latest week to May 31, 2024 saw the CME Fedwatch continues to presume just 2 rate cut in 2024; with 45% probability of the event happening. However, despite the hawkish speeches, the sharply lower GDP and steady inflation got rid of the probability of a 25 bps rate hike. 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	4.4%	95.6%	Nil
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.5%	15.7%	83.8%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	0.2%	7.5%	47.0%	45.2%	Nil
Nov-24	Nil	Nil	Nil	Nil	0.1%	2.0%	17.2%	46.6%	34.1%	Nil
Dec-24	Nil	Nil	Nil	Nil	1.2%	10.6%	33.7%	39.6%	15.0%	Nil
Jan-25	Nil	Nil	Nil	0.4%	4.3%	18.3%	35.7%	31.4%	10.0%	Nil
Mar-25	Nil	Nil	0.2%	2.2%	10.8%	26.4%	33.7%	21.4%	5.3%	Nil
Apr-25	Nil	0.1%	0.9%	5.1%	16.0%	28.8%	29.6%	16.0%	3.5%	Nil
Jun-25	Nil	0.5%	3.0%	10.5%	22.3%	29.2%	22.9%	9.9%	1.8%	Nil
Jul-25	0.2%	1.4%	5.9%	15.0%	25.0%	26.8%	17.9%	6.8%	1.1%	Nil

Data source: CME Fedwatch

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

• The key focus in Fed speak this week was the inputs coming from governors including John Williams, Michelle Bowman, Loretta Mester, and Neil Kashkari. Most of the speeches in the week typically leaned towards the hawkish side, especially after the FOMC minute and the lower than expected initial jobless claims last week.
• The big data point was PCE inflation for April which came in steady at 2.7% with core PCE inflation steady at 2.8%. While PCE food inflation was lower in April 2024, the PCE energy inflation bore the brunt as the disruptions in the oil supply chain continued to keep the prices of oil and energy products buoyant.
• The most important data point in the week was the second estimate of Q1-GDP, which came in 30 bps lower at 1.3%, compared to 1.6% in the first estimate. Also, this is sharply lower than 3.4% in Q4 and 4.9% in Q3. The good news is that low GDP can be a good reason for the Fed to finally embark on rate cuts.

Let us finally turn to the key monetary triggers in the coming week to June 07, 2024, which could have an impact on the CME Fedwatch.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO JUNE 07, 2024

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

• The outcome of the OPEC meeting will be known in this week, wherein the supplies will be reviewed. The OPEC is worried that the non-OPEC nations are making the best of price rises and may push for increasing supplies. There is already pressure from the African lobby and that is likely to temper oil prices and energy inflation.
• The Atlanta Fed estimate for Q2 GDP stands steady at 2.7% and that is the estimate for the current week also. However, the GDP downgrade for Q1 could lead to lower GDP estimate for Fed Atlanta GDP. That would add the base case for lowering of rates since the impact on the economic growth is already visible; to prevent economic impact.
• The crude oil inventories as reported by API will hold the key. Last week, the API inventories fell by -4.156 Million Barrels. However, despite the sharp drawdowns in the inventory, the oil price did not go up. Hence it is not certain how the correlations will work out in the coming week. The other data point to watch will be the Fed balance sheet, which has tapered marginally to $7.284 Trillion; a good $2 Trillion from the peak.

We are in the midst of interesting times with the last mile inflation still not giving too many clear signals. However, it is clear that rate cuts are unlikely to be taken up for consideration before September.

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 gone up sharply. Secondly, the CME Fedwatch had pencilled in the possibility of a rate hike last week, but that has been eliminated after the stable PCE inflation data and sharply lower GDP second estimate for Q1-2024. As of date, the CME Fedwatch is pencilling in a 55% probability that the rate cuts would commence in the September 2024 Fed meet. The probability of 2 rate cuts in 2024 currently stands at 44%. 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 were back last week. However, after the PCE inflation came in steady at 2.7% and Q1 GDP second estimate got sharply downgraded, the probability of rate hike has once again been discounted. Now it is static rates or lower rates.
• What about the rate cuts on the downside. The projection still stays at 2 rate cuts in 2024, although the probability is marginally higher at 44% now. There is a 55% probability that the first rate cut will happen in September 2024; so effectively, the data has moved towards a dovish tilt in the current week. Let us turn to the longer term probabilities for next year, although that is quite hazy. By July 2025, there is a 74% probability of 3 rate cuts but just about 53% 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; based on how the CME Fedwatch stands today.

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. For now, the hawks are calling the shots but things could change if data is supportive. Steady PCE inflation and sharply lower GDP growth estimates may be the first stepping stone for justifying a rate cut.