Weekly Musings – CME Fedwatch for week to September 20, 2024

25 Sep 2024 , 05:35 PM

MICHELLE BOWMAN’S DISSENT NOTE AFTER 19 YEARS

Dissent notes are rather rare in the FOMC meetings since consensus is arrived at well in advance. For the first time in 19 years, there was a dissent note this time, with governor Michelle Bowman objecting to the 50 bps rate cut. The last time, there had been a dissent vote in the FOMC meeting was by Marc Olsen, way back in the year 2005. Bowman said, she would have preferred a 25 bps rate cut rather than an ultra-aggressive 50 bps cut. Here are 5 key reasons why Michelle Bowman put up a dissent vote.

1. Michelle Bowman was in sync with the view that in the light of the progress on the inflation front made since mid-2023, as well as the cooling labour market, there was a strong base case to cut rates. However, Bowman was of the view that since the Fed was changing its direction after a log gap, it could have been tad more calibrated. Front-loading betrays a rather desperate image, indicating that hard landing was almost there.
2. Bowman felt that neither the labour data, nor the GDP data really justified such an aggressive start to rate cuts by 50 bps, instead of 25 bps. She refuted the argument that recent jobs data had raised concerns of a hard landing. Michelle Bowman underlined that the US economy was on sound footing if you see the personal consumption and the recovery in Q2-GDP growth at 3%. Rise in unemployment was more cyclical since hiring may have softened, but layoffs still very low. It was hardly an emergency situation.
3. Bowman has been one of hawks in the Fed who believed that the pecking order for the Fed should be inflation first followed by unemployment. However, she underlined that the focus was always to bring down wage growth, which was achieved. According to Bowman, labour data had become tentative as it was tough to assess the impact of recent immigration flows. With strong consumption trends, the fears of labour data hinting at an economy slowdown were largely baseless.
4. The real concern for Governor Michelle Bowman, however, was that inflation continues to remain the big challenge and it was inappropriate to talk about a shift in focus to jobs. For instance, headline inflation at 2.5% remains decisively above the Fed target of 2.0%. Normally, the last mile is the toughest and Fed has to contend with that. Also, there are signs of core inflation making a comeback; and it has risen 30 bps in the last 2 months. Bowman warns not to get lulled by the sharp fall in crude oil prices; as it does not reflect the intense strife in the Middle East and West Asia.
5. Now for the most important part. According to Bowman, higher prices have the worst impact on the most vulnerable lower and middle-income households. Long term real growth can only be sustained if stable inflation of 2% is ensured, but that narrative could change with such aggressive in rate cuts. If inflation were to return, these vulnerable segments of the economy would be impacted the most. That is a word of caution.

According to Bowman, there are also 2 perception issues. Firstly, the FOMC’s policy action of cutting rates by 50 bps can be interpreted as a declaration of victory over inflation; which would be an erroneous message. Secondly, should inflation return, there will also be a spike in expected inflation, something the Fed seeks to continually monitor and manage.

RECAP – CME FEDWATCH FOR PREVIOUS WEEK ENDED SEPTEMBER 13, 2024

Let us start with a recap of the week to September 13, 2024; and how the CME Fedwatch panned out during the week. By the week to September 13, 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	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. But there were other data points too, during the week.

• The US CPI inflation was announced on September 11, 2024. The consensus expectation had been 30 bps lower inflation at 2.6%. However, actual consumer inflation in the US fell by 40 bps to 2.5%. That, combined with the loose labour data had offered the perfect setting for the Fed to commence rate cuts on September 18, 2024.
• Consumer inflation expectations and the Atlanta Fed GDP estimates were also out in the week to September 20, 2024. While consumer inflation was steady at around 3.0%, there was a sharp bounce in the Atlanta Fed GDP estimates. In previous weeks, the estimate for Q3 GDP growth has been sharply downsized from 2.5% to 2.1%. This week, the estimate has been reverted back to 2.5%; showing that growth remains robust.
• With Brent Crude stable around $70/bbl, the action shifts to the spike in Federal Budget deficit. The August budget deficit was estimated at $285 billion, but came in sharply higher at $380 Billion. This is sharply higher than expected and has the potential to trigger inflationary pressures ahead of US presidential elections.

Let us now move to the current week to September 20, 2024 and see how the key data points impacted the CME Fedwatch.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO SEPTEMBER 20, 2024

The latest week to September 20, 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	200-225 #	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	51.4%	48.6%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	24.1%	50.1%	25.8%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	8.4%	33.1%	41.7%	16.9%	Nil	Nil
Mar-25	Nil	Nil	Nil	2.3%	15.3%	35.5%	34.7%	12.1%	Nil	Nil	Nil
May-25	Nil	Nil	1.9%	13.1%	32.0%	34.9%	16.0%	2.1%	Nil	Nil	Nil
Jun-25	Nil	1.3%	9.5%	26.0%	34.0%	22.0%	6.5%	0.7%	Nil	Nil	Nil
Jul-25	0.5%	4.2%	15.3%	28.8%	29.8%	16.6%	4.5%	0.4%	Nil	Nil	Nil
Sep-25	1.6%	7.2%	18.9%	29.0%	26.2%	13.3%	3.4%	0.3%	Nil	Nil	Nil
Oct-25	2.6%	9.0%	20.5%	28.6%	24.3%	11.8%	2.9%	0.3%	Nil	Nil	Nil
Dec-25	3.4%	10.0%	21.2%	28.2%	23.2%	11.0%	2.7%	0.2%	Nil	Nil	Nil

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

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 Fed opted to taken an aggressive bite by cutting rates by 50 bps signalling that the combination of rising unemployment and falling inflation had offered the perfect setting for the Fed to up its ante on rate cuts. The Fed not only cut rates by 50 bps but also guided for another 50 bps of rate cut by the end of 2024, with Michelle Bowman being the sole dissenting vote at the FOMC.
• The Fed also offered the quarterly updated of its long term projections of interest rates, inflation, GDP growth and labour data for the next 3-4 years and the long term. There were some key changes. The unemployment by the end of 2024 was upped by 40 bps over the June estimate to 4.4% while PCE inflation was cut 30 bps to 2.3% in 2024. The message was that front loading of interest will be the story in the next 18 months.
• The Atlanta Fed GDP estimate for Q3 has now been upped to 3.0%, rising nearly 90 bps in the last 2 weeks. Clearly, growth is back with a bang. For the week, the jobless claims also came in sharply lower at 219K, compared to the expectation of 230K. In a surprise move, the NY Empire State manufacturing index was expected to contract by -4.5% for September, but is now likely to grow at 11.5%. That is a big shift.

Let us now look at what are the key data points that will influence the CME Fedwatch in the coming week to September 27, 2024.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO SEPTEMBER 27, 2024

The week to September 20, 2024 will be dominated by the US PCE inflation data and the final estimate of Q3 GDP. There are 3 key data points to look out for.

• The final estimate of Q2 GDP will be announced by the US Bureau of Economic Analysis (BEA). The second estimate had pegged the Q2 GDP growth at 3.0% and that is likely to be maintained in the third estimate too. This largely gels with the estimates put out by the Atlanta Fed GDP on Q3 GDP for the US economy.
• A day after the GDP data announcement, the US BEA will also announced the PCE inflation for August. The PCE inflation is already at 2.5% as of July and for August, even the consumer inflation fell by 40 bps to 2.5%. The August PCE inflation is expected in the range of 2.4% to 2.5%, which should be a good story for front loading of rate cuts.
• Fed speak will assume importance in the coming week in the aftermath of the decision to cut rates by 50 bps in the Fed meeting last week. In the coming week, speeches are expected from Raphael Bostic, Michelle Bowman, Neil Kashkari, and even the Fed chair, Jerome Powell himself. That should offer credible indications on the road ahead.

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

RATES TRAJECTORY – FED TO SUSTAIN FRONT-LOADING OF RATE CUTS

The aggression of the Fed in the September 18, 2024 meeting put all speculations to rest on whether the Fed will opt for a calibrated move or it would front load rate cuts. The Fed has clearly opted for front loading rate cuts and it wants to give a message that the central bank means business and can act decisively and quickly on both sides. After all, the unemployment figure is uncomfortably high at 4.2% while the consumer inflation and the PCE inflation are now comfortably low at 2.5%.

However, there was a dissent vote from Michelle Bowman, who would have preferred a 25 bps rate cut over a 50 bps rate cut. Also, the budget deficit of the US government is a major challenge as it came in at a whopping $380 Billion against the original estimate of around $270 Billion. That has the potential to be very inflationary and it remains to be seen how the Fed will handle this dichotomy. A lot will depend on how the Fed interprets the budget deficit and its likely impact on inflation in the US economy.

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

• With the September rate cut of 50 bps done and dusted, the focus shifts to November and December FOMC meets. The CME Fedwatch assigned a probability of 100% to 25 bps rate cuts and 51.4% probability to another 50 bps rate cut by November 2024.
• Let us look at the first milestone of December 2024. By then, another 50 bps rate cut (100 bps in all) is considered certain. Also, there is a probability of 74.2% for an additional 75 bps rate cut. So, it could either be a total rate cut of 100 bps or 125 bps in all by end of year 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 99.3% probability for 175 bps rate cuts from the peak and 92.8% chance for 200 bps rate cuts from the peak by June 2025.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 97.1% probability for 200 bps of rate cuts from the peak and a high probability of 86.1% for 225 bps of rate cuts by December 2025. There is a 63.0% probability that the Fed could close year 2025 having cut rates by a full 250 bps from peak and moved to (2.75%-3.00%).

Like in the past, the FOMC has been categorical that it would be totally data driven. However, the recent Fed statement shows that it is serious about front loading rate cuts to ensure that the US economy remains on track. For now, we have to await the minutes of the Fed meeting after 21 days to get an idea of the gist of the discussions that went into the decision by the Federal Reserve to front load rate cuts.