Weekly Musings – CME Fedwatch for week to October 18, 2024

21 Oct 2024 , 01:39 PM

WALLER’S PRESCRIPTION FOR 3 MACRO SCENARIOS

Speaking recently at the world renown, Hoover Institution at Stanford Institution; Governor Christopher Waller, painted 3 distinct macro scenarios in the US and also guided on how the Fed would react in each of these respective scenarios.

1) According to Cristopher Waller, the first scenario is one where the overall strong economic developments continue, with inflation nearing the FOMC’s target and the unemployment rate moving up only slightly. This is the most likely, and also the most preferred scenario for the US Federal Reserve. According to Waller, in such a scenario the Fed would proceed with moving policy toward a neutral stance at a deliberate pace. However, this path would be based on the judgment that the risks to both sides of the Fed dual mandate (2% inflation and full employment) are balanced. In this scenario, the focus of the US Federal Reserve would be to keep inflation near the 2% mark and not to try and slow the economy either deliberately or unnecessarily.

2) The second scenario, according to Waller, is possible, but less likely. This scenario envisages a situation wherein the PCE inflation falls materially and meaningfully below 2% for a reasonable period of time, and / or the labour market significantly deteriorates. The message here is would be that consumer and investment demand in the US economy was falling. It would also imply that the FOMC was woefully behind the curve, and it would imply that the Fed should move to neutral faster by front-loading rate cuts. The only risk in this scenario is that it could take policy to a point of no-return.

3) The third scenario applies if inflation unexpectedly spikes either because of stronger-than-expected consumer demand or wage pressure. It could also be triggered by supply shocks (like West Asia crisis) that pushes up inflation. One does not have to stretch the memory too far to grasp this scenario. The recovery from the pandemic recession, was a classic example of the demand being stronger than expected and supply weaker than expected. These kind of imbalances can trigger supply shocks. This would call for pausing on rate cuts as long as the labour market was robust. Rate cuts could resume later.

RECAP – CME FEDWATCH FOR PREVIOUS WEEK ENDED OCTOBER 11, 2024

Let us start with a recap of the week to October 11, 2024; and how the CME Fedwatch panned out during the week. Data flows in recent weeks have been rather steady as the inflation and growth data now appears to be trending around certain rational expectations. Macros have been largely stable, and that has helped Fedwatch to find equilibrium.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	89.5%	10.5%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	84.4%	15.0%	0.6%
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	68.5%	28.0%	3.3%	0.1%
Mar-25	Nil	Nil	Nil	Nil	Nil	Nil	65.8%	29.7%	4.3%	0.2%	Nil
May-25	Nil	Nil	Nil	Nil	Nil	43.5%	41.9%	12.9%	1.6%	0.1%	Nil
Jun-25	Nil	Nil	Nil	Nil	28.2%	42.5%	23.1%	5.6%	0.6%	Nil	Nil
Jul-25	Nil	Nil	Nil	9.9%	33.2%	35.7%	17.0%	3.8%	0.4%	Nil	Nil
Sep-25	Nil	Nil	3.2%	17.5%	34.0%	29.6%	12.7%	2.7%	0.3%	Nil	Nil
Oct-25	Nil	0.8%	6.6%	21.4%	33.0%	25.6%	10.4%	2.2%	0.2%	Nil	Nil
Dec-25	0.2%	2.0%	9.6%	23.8%	31.4%	22.5%	8.7%	1.8%	0.2%	Nil	Nil

Data source: CME Fedwatch

A quick reading of the CME Fedwatch post the Fed minutes announcement tells you that the rate cut probabilities have not really changed much since they stabilized in a tight range. However, the dovishness is gradually plateauing. Here is a quick take.

•  The minutes of the Fed meeting of September 18, 2024 was announced in this week. The minutes showed a much wider dichotomy that visible to a cursory reading of the policy statement. The minutes revealed that the verdict in favour of 50 bps rate cut may have looked decisive; but the underlying debate was fairly fractured between extreme views. Michelle Bowman may have been the only dissent vote, but several other members also preferred a 25 bps rate cut over a 50 bps rate cut. That goes to show that maintaining the pace of dovishness in upcoming meetings may not be all that easy.
• US consumer inflation for September 2024 came in at 2.4%, which is 10 bps lower than the level seen in August. The US announces the consumer inflation in the second week, but it is the PCE inflation announced in the last week that is the benchmark for the Fed. However, the consumer inflation does set the tone for PCE inflation. The inflation story also had dichotomies. Food inflation was up 20 bps while core inflation was up 10 bps. Lower inflation was an outcome of energy basket contracting -6.8% in Sep-24, compared to -4.0% in August. The key to the inflation story could be in global crude oil prices.
• The Atlanta Fed US GDP growth estimate for Q3-2024 (third quarter ending September 2024) came in at 3.2%, indicating that full year growth may end up well above 2.5%. The crude oil inventories saw s sharp build-up of 5.810 Million barrels against expected build-up of just 2.000 Million barrels. This will keep oil prices subdue for the time being.

CME Fedwatch (which had taken the lead in aggressive dovishness) is turning less dovish as growth appears to be a lot more robust and the inflation still looks vulnerable to supply shocks. The CME Fedwatch is still pencilling in overall rate cuts to the tune of 75 bps to 100 bps by the end of 2024 and rate cuts to the tune of 175 bps to 200 bps overall by end of 2025. Let us now turn to the triggers for the CME Fedwatch in the just concluded week.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO OCTOBER 18, 2024

The latest week to October 18, 2024 saw the CME Fedwatch continue to factor 3-4 rate cuts in 2024, but also toned down to just 175-200 bps rate cut by end of 2025.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.6%	99.4%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.5%	75.6%	23.9%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	57.5%	36.4%	5.8%	Nil
Mar-25	Nil	Nil	Nil	Nil	Nil	0.3%	52.4%	38.3%	8.5%	0.5%	Nil
May-25	Nil	Nil	Nil	Nil	0.2%	34.1%	43.2%	19.0%	3.3%	0.2%	Nil
Jun-25	Nil	Nil	Nil	0.2%	24.9%	40.7%	25.5%	7.6%	1.0%	Nil	Nil
Jul-25	Nil	Nil	0.1%	9.9%	31.1%	34.8%	18.5%	5.0%	0.6%	Nil	Nil
Sep-25	Nil	Nil	3.7%	17.7%	32.5%	28.8%	13.5%	3.4%	0.4%	Nil	Nil
Oct-25	Nil	0.8%	6.5%	20.7%	31.7%	25.7%	11.5%	2.8%	0.3%	Nil	Nil
Dec-25	0.2%	1.9%	9.4%	23.0%	30.5%	22.8%	9.7%	2.3%	0.3%	Nil	Nil

(Data source: CME Fedwatch)

The latest week to October 18, 2024 will be dominated by the FOMC minutes and the announcement of the consumer inflation by the US.

• In key Fed speak, Christopher Waller, Raphael Bostic, and Neil Kashkari spoke in during the week at different forums. Neil Kashkari, in his speech underlined that the rate cuts would continue, but it would be more calibrated in future. Even Christopher Waller suggested that the Fed stands prepared with a Plan-B for every possible macro surprise. However, he expected 2% inflation and full employment objectives to be broadly in balance and the rate cuts to be carefully calibrated in coming months.
• The consumer inflation expectations continued to stay at 3%, as was the case in previous few weeks. That is broadly in sync with the target of moving PCE inflation towards the 2% mark. The other big data point in the week was the initial jobless claims falling from 260K last week to 241K in the current week. That was exactly as per estimates, but underline the fact that the 4.3% unemployment reading in July 2024 may have been slightly exaggerated and a sub-4% unemployment was looking more likely.
• In other data points to watch in the coming week; there would be focus on the EIA weekly crude inventories. It was expected to show an accretion of +1.800 Million barrels during the week after the bumper performance in the previous week. However, when the actual numbers came in, oil inventories had actually seen a drawdown of -2.191 Million barrels. This could put some pressure on crude oil prices. On the subject of oil, the OPEC monthly report projected a sharp fall in Chinese oil demand, which led to Brent Crude cracking from $79/bbl to $73/bbl by the end of the week.

CME Fedwatch is getting less dovish as the growth appears to be more robust that expected while the inflation looks vulnerable to supply side shocks or even a demand shock. The CME Fedwatch is still pencilling 75 bps to 100 bps overall rate cut by end of 2024 and 175 bps to 200 bps overall by end of 2025. Let us turn to the triggers for the coming week.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO OCTOBER 25, 2024

The coming week to October 25, 2024 will be dominated by the FOMC minutes and the announcement of the consumer inflation by the US.

•  In key Fed speak in the coming week, Michelle Bowman, Neil Kashkari, Mary Daly, and Patrick Harker will be addressing various forums. The key to the coming week would be whether the Fed will maintain the current aggression or would tone it down. For now, it looks like there could be some front loading of rate cuts in 2024 and the Fed may eventually a lot slower in 2025. Bowman and Kashkari are professed hawks and their viewpoint will hold a lot of interest for the financial markets.
• The S&P Global Composite PMI for October will be announced in the coming week. PMI (purchase managers index) is a key high frequency indicator. In the US, the PMI manufacturing has been consistently under 50 while the PMI services has been consistently above 50. In PMI, the 50 mark is the cut-off between expanding output and contracting output. Manufacturing PMI is expected to improve in the latest reading. Initial jobless claims are expected to go up in the week from 241K to 243K, but last week it had surprised on the downside.
• In other data points to watch in the coming week; the Atlanta Fed GDP for Q3 is expected to be robust around 3.4%. This number has been gradually upgraded in the last few weeks. This will be the last week of expectations since the first advance estimate of Q3GDP growth for the US economy will be out in the last week of this month. That data, along with PCE inflation and October jobs data will set the tone for the upcoming FOMC meet, scheduled on November 07, 2024.

Let us finally turn to the big story of how all these news flows added up to influence the CME Fedwatch probabilities in the latest week.

RATES TRAJECTORY – MORE UPFRONT, OR MORE BACK-ENDED?

On September 18, 2024, the Fed opted to front-load rate cuts by starting off with 50 bps. The Federal Reserve, perhaps, wanted to send a clear message that the central bank means business and can act decisively, either ways. However, some of the recent data flows are likely to put some constraints on the extent of dovishness that the Fed can display. For example, the second quarter final GDP and the recent jobs data are indicating that hard landing may be off the agenda for now. Also, the Fed minutes suggest that, most FOMC members would have preferred a 25 bps rate cut; although Michelle Bowman was the only member to put up a dissent vote. The recent consumer inflation data does betray some potential risks to inflation; with the strife in West Asia getting worse. Rising oil prices have the potential to be inflationary.

Here is a quick look at how the rate cut probabilities panned out after all the recent key data points like the unemployment data, consumer inflation data, minutes of the Fed meeting etc were already factored into the CME Fedwatch. Here is our reading of the CME Fedwatch chart.

• With the September rate cut of 50 bps done for now, the focus shifts to November and December FOMC meets. The CME Fedwatch has assigned a probability of 100% to 25 bps rate cut in November 2024; with anything beyond that not exactly on the radar.
• What about the first milestone of December 2024? By then, there is 76.1% probability of additional 50 bps rate cut (100 bps in all). Also, there is a small probability of 23.9% for an overall 75 bps rate cut. So, it is most likely 100 bps from the peak and possibly just 75 bps of rate cuts overall by the end of December 2024.
• Let us turn to June 2025 milestone. The CME Fedwatch is assigning 91.4% probability for overall 150 bps rate cuts from the peak and 65.8% probability for 175 bps rate cut from the starting point of the cycle. Both these probabilities have clearly moved lower in the last one week.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 87.7% probability for 175 bps of rate cuts from the peak and a high probability of 65.9% for 200 bps of rate cuts by December 2025. So, it looks very likely that the US Fed rate could settle at (3.25%-3.50%) by close of December 2025; although incoming data could likely restrict it to just 175 bps rate cut from the peak. That decision would be largely a play on incoming data flows in the interim period.

Will the Fed adhere to such an aggressive time table? To be fair, the Fed view and the CME Fedwatch view are now almost in sync. However, if you go by the recent speeches of Kashkari and Waller, the Fed would be open to a more calibrated and gradual reduction in rates. Of course, if there is a macro shock; either in the form of inflation spike or in the form of jobs slump, the Fed will trigger its Plan-B. An overall rate cut (from the peak) of 75-100 bps by end of 2024 and an overall rate cut of 175-200 bps by end of 2025 looks like the most likely scenario for now!