Weekly Musings – CME Fedwatch for week to September 13, 2024

18 Sep 2024 , 12:00 PM

CHRIS WALLER THINKS TIME IS RIPE OR RATE CUTS

Apart from the data flows, Fed statement and the Fed minutes, the one additional factor that has a strong bearing on the CME Fedwatch is the speeches given by Fed members. The beauty is that they do not have to agree and can each offer their own opinion. FOMC member, Chris Waller things it is time for rate cuts. Here is why.

• Waller argues that the persistent progress that the Fed had made on the inflation control front had been really impressive, if seen from a longer lens. That also means that the balance of risks had shifted toward the employment side of the dual Fed mandate of price stability and full employment. In short, monetary policy must change its approach and focus accordingly.
• Justifying a series of rate cuts in the months ahead, Chris Waller underlined that the employment report for July and August had been too soft. Job creation had slowed joblessness spiked to 4.3% in July and 4.2% in August. The absolute numbers of unemployed remain the same, even though the rate has fallen.
• Contrary to popular apprehensions, Waller underscored the fact that a spike in unemployment is not directly a sign of hard landing. While inflation had made progress in tapering, the price to pay was looser labour data. Waller feels that the time is ripe to rectify that balance and reduce rates to bring unemployment rate back to around 3.5%.

There is one more debate that Waller dwelt on in his speech at the University of Notre Dame. Can the GDP growth and improvement in employment ratio co-exist with 2% inflation target? Ironically, it can coexist.

YES, LOW INFLATION DESPITE RATE CUTS

For a long time, we thought it is hard for high growth, and low unemployment to co-exist with low rates of interest. Waller believes this is perfectly possible. Here is how.

• There is evidence to believe that GDP growth is continuing at a solid pace. Real gross domestic product (GDP) grew at 2.2% (annualized) in the first half of this year. The second estimate of real GDP growth for Q2-2024 has been upgraded to 3.0%; more than double the GDP growth in the first quarter. The Atlanta Fed estimate of Q3 GDP shows that 2.2%-2.5% real GDP growth should be perfectly sustainable.
• Has consumer sales taken a hit and have consumer sentiments on the defensive? Recent numbers show that households continue to spend as their finances remain healthy overall; thanks to the massive cash infusion post the pandemic. The increase was across different categories of goods. Even the non-manufacturing sector has expanded sharply.
• Waller has red-flagged only one concern; that of non-farm payrolls report, especially the revisions of previous month numbers. Payrolls rose by 142,000 in August compared with 89,000 in July. However, June and July saw a heavy downgrade of payroll numbers and there are concerns of a similar downgrade for August data also. It does look like the jobs may struggle to absorb the labour force; but some impact of automation is inevitable.

To sum up, Waller feels it is perfectly possible for the US economy to grow GDP in tandem with falling inflation and moderating joblessness; with unemployment closer to 3.5%.

RECAP – CME  FEDWATCH FOR PREVIOUS WEEK ENDED SEPTEMBER 06, 2024

Let us start with a recap of the week to September 06, 2024; and how the CME Fedwatch panned out during the week. By the week to September 06, 2024, the markets had more or less crystallized that the first rate cut would happen by September 2024 and also assigned a high probability of 3-4 rate cuts happening in 2024. Here are CME Fedwatch probabilities.

Fed Meet	250-275#	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	30.0%	70.0%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	17.6%	53.5%	28.9%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	12.3%	42.7%	36.3%	8.7%	Nil	Nil
Jan-25	Nil	Nil	Nil	5.6%	26.1%	39.8%	23.8%	4.8%	Nil	Nil	Nil
Mar-25	Nil	1.8%	12.2%	30.5%	34.7%	17.7%	3.2%	Nil	Nil	Nil	Nil
May-25	1.7%	11.8%	29.8%	34.5%	18.3%	3.8%	0.1%	Nil	Nil	Nil	Nil
Jun-25	9.3%	23.4%	32.8%	24.1%	9.0%	1.4%	Nil	Nil	Nil	Nil	Nil
Jul-25	19.9%	27.7%	28.9%	17.2%	5.5%	0.8%	Nil	Nil	Nil	Nil	Nil
Sep-25	28.9%	28.0%	25.1%	13.4%	4.0%	0.5%	Nil	Nil	Nil	Nil	Nil
Oct-25	35.5%	27.4%	22.3%	11.2%	3.2%	0.4%	Nil	Nil	Nil	Nil	Nil
Dec-25	38.7%	26.8%	21.0%	10.3%	2.9%	0.4%	Nil	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

The week to September 06, 2024 had limited data flows, so the dominant data point was the US unemployment report and jobs data. Here are the key triggers of previous week.

• The big data point was the jobs report published by the Bureau of Labour Statistics (BLS) on September 06, 2024. The unemployment rate tapered by just 10 bps to 4.2%, but the numbers remained static in absolute terms. The non-farm payroll additions came in at 142K, but downgrades are very likely. It opens the gates to an almost assured 25 bps rate cut on September 18, 2024 and possibly 50 bps also.
• There appeared to be the first signs of changing undertone among FOMC members. While the FOMC still has its share of hawks, there are the likes of Christopher Waller, who even suggest front loading rate cuts in 2024. According to Waller, not only is the time ripe for a rate cut, but the time is also ripe to shift focus from inflation control to supporting the full employment target more aggressively.
• One data point that is still ambivalent is the Atlanta Fed GDP, which came in sharply lower at 2.0% for Q3, compared to the earlier estimate of 2.5%. Amidst falling crude prices, the drawdowns of inventories continued. In the week, the markets were expecting drawdown of (0.600) Million barrels, but the actual drawdown was sharply higher at (6.873) Million barrels. However, crude cracked below $70/bbl in the week.

Let us now turn to the big triggers for the CME Fedwatch in the latest week and how the triggers could play out.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO SEPTEMBER 13, 2024

The latest week to September 13, 2024 saw the CME Fedwatch continue to factor in 3-4 rate cuts in 2024, but also suggested up to 8-9 rate cuts by December 2025.

Fed Meet	250-275#	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	67.0%	30.0%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	29.6%	52.0%	18.4%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	19.0%	43.9%	30.5%	3.6%	Nil	Nil
Jan-25	Nil	Nil	Nil	9.8%	31.9%	37.0%	18.1%	3.2%	Nil	Nil	Nil
Mar-25	Nil	4.2%	19.3%	34.2%	28.9%	11.6%	1.8%	Nil	Nil	Nil	Nil
May-25	3.7%	17.7%	32.7%	29.5%	13.4%	2.8%	0.2%	Nil	Nil	Nil	Nil
Jun-25	16.9%	28.8%	30.3%	17.6%	5.5%	0.8%	Nil	Nil	Nil	Nil	Nil
Jul-25	27.5%	29.4%	25.7%	13.2%	3.8%	0.6%	Nil	Nil	Nil	Nil	Nil
Sep-25	34.3%	28.5%	22.7%	11.0%	3.0%	0.4%	Nil	Nil	Nil	Nil	Nil
Oct-25	37.9%	27.7%	21.2%	10.0%	2.7%	0.4%	Nil	Nil	Nil	Nil	Nil
Dec-25	39.7%	27.3%	20.5%	9.5%	2.6%	0.4%	Nil	Nil	Nil	Nil	Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

The big data point in the week was the CPI inflation announced by the Bureau of Labour Statistics in the US. The inflation marked the last big data point before the Fed announces its monetary policy on September 18, 2024.

• The US CPI inflation was announced on September 11, 2024. The consensus expectation was a 30 bps fall from 2.9% to 2.6%. However, in reality the consumer inflation in the US fell by 40 bps to 2.5%. That, combined with the loose labour data last week, offers the perfect setting for the Fed to commence rate cuts on September 18, 2024.
• The consumer inflation expectations and the Atlanta Fed GDP estimates were also out in the week to September 13, 2024. While the consumer inflation is steady at around 3.0%, like in the previous weeks, there was a sharp bounce in the Atlanta Fed GDP estimates. In the previous week, the estimate for Q3 GDP growth has been sharply downsized from 2.5% to 2.1% on average. This week, the estimate has been again hiked back to 2.5%.
• With oil falling below $70/bbl in the Brent market, the action has shifted to what is happening to the Federal Budget deficit. The Budget deficit for August was estimated at $285 billion, but came in sharply higher at $380 Billion. This is sharply higher than expected and has the potential to be inflationary ahead of elections.

Let us now turn to the final story of how all these flows added up to influence the CME Fedwatch probabilities in the coming week.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO SEPTEMBER 20, 2024

The week to September 20, 2024 will be dominated by the Fed policy statement on Wednesday. There are 3 key data points to look out for.

• The FOMC statement will be out on Wednesday, September 18, 2024. The general consensus is that there would be 25 bps rate cut and that is what even the Fed has confirmed. However, after the speech by Waller last week, there is a high probability of a 50 bps rate cut. That could be the big decision, plus the language of the Fed.
• September being the third quarter for the US economy, will also mark the Fed announcing its long term projections of interest rates, inflation, GDP growth and labour data for the next 3-4 years and the long term. This is likely to give a picture of how the Fed sees the trajectory of rates, which is why it will be as critical as the Fed statement.
• The week will be dominated by the FOMC statement and the Economic Projections. However, other data points that will have a bearing on the CME Fedwatch would include the EIA and the API crude stock reports, the current account deficit data as well as the data on industrial production and the jobless claims for the week.

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

RATES TRAJECTORY – FED LIKELY TO FRONT-LOAD RATE CUTS

Over the last few weeks, it has been amply clear that the Fed will trigger its first rate cut in its September 18, 2024 monetary policy statement. However, there is still a debate over whether it would be a calibrated move or a front loaded move. In the last two weeks; the unemployment figure at 4.2% for August and the consumer inflation at 2.5% for August, makes a strong case for the Fed to be aggressive and frontload the rate cuts. However, the final decision will be taken by the Fed based on the larger picture as the Fed would also be keen to ensure that the inflation problem, does not get out of hand in a worst-case scenario.

Even  as the signals do hint at the Fed leaning towards a 50 bpd rate cut rather than a 25 bps rate cut, one data point that could prove to be a show spoiler is the budget deficit data. For August 2024, the budget deficit of the US government came in at a whopping $380 Billion against the original estimate of around $270 Billion. That has the potential to be very inflationary and hence that may put the Fed on the back foot as far as front loading the rate cuts are concerned. A lot will depend on how the Fed interprets the budget deficit and whether it would give that as a reason for just sticking to 25 bps rate cut in September.

Here is what the CME Fedwatch table above is indicating in terms of the probability of rate cuts in the next 16 months.

• The CME Fedwatch has assigned a high probability of 67.0% to a 50 bps rate cut in the September meeting; while 25 bps rate cuts is already taken as a done deal by the CME Fedwatch. However, projections beyond September are already hinting at front-loading.
• The CME Fedwatch assigned a probability of 100.0% to 50 bps rate cuts and 79.6% probability to 75 bps rate cut by November 2024. A 75 bps rate cut by November would, most likely, be the outcome of a 50 bps rate cut on September 18, 2024.
• Let us look at the first milestone of December 2024. By then, a 75 bps rate cut is considered certain. Also, there is a probability of 96.4% for a 100 bps rate cut. So, it could very well be 50 bps in September 2024 and another 50 bps by December 2024.
• Probabilities beyond 2024 are still evolving and will offer more clarity once the current year action is visible. Let us look at June 2025. The CME Fedwatch is assigning 99.2% probability for 175 bps rate cuts and 93.7% chance for 200 bps rate cuts by June 2025.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 97% probability for 200 bps of rate cuts and a high probability of 87.5% for 225 bps of rate cuts by December 2025. There is a 67% probability that the Fed could close year 2025 having cut rates by a full 250 bps from current levels (2.75%-3.00%).

Like in the past, the FOMC has been categorical that it would be totally data driven. However, the recent speech by Waller at the University of Notre Dame underlines that the Fed is open to the idea of going beyond 25 bps. A lot will be visible in the long term economic projections, which will give an indication of the kind of long term macro direction pencilled by the FOMC members. The first signs of the Fed intent will be clear on September 18, 2024; when the Fed policy statement is announced.