Weekly Musings – CME Fedwatch for week to September 27, 2024

1 Oct 2024 , 09:46 AM

US GROWTH RATE FOR Q2-2024 BETTER THAN EXPECTED

When Michelle Bowman put up her dissent note at the FOMC meeting on September 18, 2024, she had made two key points. She underlined that the Fed may have declared victory in its war over inflation too early and that it was getting overly concerned about the pace of GDP growth. In a sense, she was right on the second point since a few swallows do not make a summer and the reality is that the Fed got overly concerned about 1 quarter of GDP slowdown and a couple of months of higher unemployment data. But, more on the GDP growth first. The second advance estimate of US GDP for Q2-2024 had been upgraded by the US Bureau of Economic Analysis (BEA) by 20 bps to 3.0%. The final estimate of Q2 GDP announced by the USBEA on September 26, 2024 has maintained the second quarter GDP growth steady at 3.0%. Ironically, even the first quarter growth of 1.4% has now been upgraded to 1.6%. That still means that the second quarter GDP growth had nearly doubled to 3.0%. The latest round of revisions surely make the sequential quarterly growth story look a lot more stable and predictable.

Let us start by traversing back to Q3-2023. Originally, the USBEA had reported GDP growth of 4.9% for that quarter. However, the latest update by the USBEA had downsized that estimate by 50 bps to 4.4%. If you look at the next quarter of Q4-2023 GDP growth; the originally growth had been pegged at 3.4%; which has now been cut to 3.2%. Finally, if you look at the most recent sequential quarter of Q1-2024 GDP growth; it has been upped from 1.4% to 1.6%. In short, now the progression looks a lot smoother and also less volatile. The growth rate of GDP in Q2-2024 is now almost at par with Q4-2024. With the Atlanta Fed GDP estimates for Q3 GDP growth already at 3.1%, that may be the new normal, which means the full year growth in GDP would be much better than the 2% that the FOMC had pegged in its last quarterly projection update. Forget about hard landing being overblown; the GDP growth rate is actually likely to be relatively healthy in 2024.

MILLION DOLLAR QUESTION; SHOULD WE FORGET ABOUT HARD LANDING?

If we go b ack to the arguments building up to the FOMC meeting on September 18, 2024 and the decision to cut rates by 50 bps, there now seems to be a dichotomy between what the FOMC feared and how the actual numbers are panning out. Michelle Bowman was, perhaps, correct in her assessment that there was too much reliance on just a couple of data points. For example, the sharp fall in GDP in Q1 was largely on account of the trade constraints imposed by the Red Sea crisis. However, Q2 has been strong despite a robust base. Also, the spike in immigration was apparently more due to the immigration impact, so calling it a statement on weak GDP growth was erroneous in the first place. If the growth in GDP sustains for the next two quarters, then one can emphatically say that the fears of hard landing may have been overblown.

RECAP – CME FEDWATCH FOR PREVIOUS WEEK ENDED SEPTEMBER 20, 2024

Let us start with a recap of the week to September 20, 2024; and how the CME Fedwatch panned out during the week. This was just after the Fed cut rates by 50 bps, so the dovishness of the Fed and the sense of celebration is evident in the probability distribution of rate cut expectations of the CME Fedwatch.

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 27, 2024 was dominated by the Fed policy statement cutting rates by 50 bps. Here is a quick dekko at the key triggers.

• The Fed opted to go for the jugular, cutting rates by 50 bps. The signal was that the combination of rising unemployment and falling inflation had offered the perfect setting for the Fed to front-load rate cuts. The Fed not only cut rates by 50 bps but also guided for another 50 bps of rate cut by end of 2024. In the FOMC statement; Michelle Bowman became the first governor to dissent in the last 19 years.
• Along with the Fed statement, the quarterly updated of long term macroeconomic projections were also put out by the Fed. There were some key changes. The unemployment rate by the end of 2024 was upped by 40 bps over June estimate to 4.4% while PCE inflation was cut by 30 bps to 2.3% for 2024. The preference was clearly in favour of front-loading of interest rate cuts.
• The Atlanta Fed GDP estimate for Q3 was upped to 3.0%, having risen by 90 bps in the last 2 weeks. It looks like growth is back. Jobless claims also came in sharply lower at 219K, compared to the expectation of 230K. Even manufacturing is showing signs of a sharp recovery in the US economy.

Let us now turn to the key data points that influenced the CME Fedwatch in the week to September 27, 2024.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO SEPTEMBER 27, 2024

The latest week to September 27, 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	53.3%	46.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	28.9%	49.7%	21.3%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	8.8%	35.3%	41.1%	14.9%	Nil	Nil
Mar-25	Nil	Nil	Nil	1.8%	14.1%	36.4%	35.8%	11.9%	Nil	Nil	Nil
May-25	Nil	Nil	1.4%	11.9%	32.4%	35.9%	16.2%	2.1%	Nil	Nil	Nil
Jun-25	Nil	0.9%	8.2%	25.2%	34.7%	23.1%	7.1%	0.7%	Nil	Nil	Nil
Jul-25	0.3%	3.5%	14.2%	28.5%	30.6%	17.5%	4.9%	0.5%	Nil	Nil	Nil
Sep-25	1.3%	6.4%	18.1%	29.1%	27.1%	14.1%	3.7%	0.4%	Nil	Nil	Nil
Oct-25	2.3%	8.1%	19.7%	28.8%	25.1%	12.5%	3.2%	0.3%	Nil	Nil	Nil
Dec-25	2.7%	8.8%	20.2%	28.6%	24.4%	12.0%	3.0%	0.3%	Nil	Nil	Nil

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

Here is a quick picture of how the rate cut probabilities panned out after the PCE inflation data for August 2024. There were some doubts about the extent of dovishness after the robust GDP data, but the 30 bps fall in PCE inflation for August set these doubts to rest. There were 3 key data points in the week.

• The third and final estimate of Q2 GDP was announced by the US Bureau of Economic Analysis (BEA). The second estimate had pegged the Q2 GDP growth at 3.0% and that was held 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; which stands now at 3.1%.
• A day after the GDP data announcement, the US BEA also announced the PCE inflation for August. The PCE inflation fell sharply from 2.5% in July to 2.2% in August. While the core PCE inflation was up by 10 bps and food inflation fell by 10 bps, the sharp fall was triggered by the energy inflation. Thanks to the sharp fall in crude prices, lower energy inflation has been a key driver of lower PCE inflation in the US.
• Fed speak was the big story in the latest week. Speaking at the Kentucky Bankers Association, Michelle Bowman held her point that the Fed would have been better off with a 25 bps rate cut, instead of a 50 bps rate cut. That would have also sent out the right message to the market. In another presentation, Adriana Kugler, supported the 50 bps rate cut and suggested that front loading of rate cuts was the need of the hour.

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

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO OCTOBER 04, 2024

The coming week to October 04, 2024 will be dominated by the US unemployment numbers to be announced on Friday. There are 3 key data points to look out for.

• The US unemployment data for September will be put out by the US Bureau of Labour Statistics (BLS) on Friday October 04, 2024. In the last 2 months, the rate of unemployment had spiked to 4.3% and 4.2% respectively. In absolute terms, the number of unemployed have been the same. That was the trigger for the rate cut front loading. For September, the unemployment rate is expected at around 4.2%, so the Fed has enough reasons to continue with its dovish stance, at least till the end of December 2024. The strategy for 2025 will evolve based on data flows.
• The all-important OPEC meeting is slated for this week. This is a critical OPEC meeting where quotas are likely to be rolled back with most of the OPEC nations getting back to full capacity production. With OPEC realizing their limited impact on price setting, they are likely to focus on making hay while the sun shines. If that happens, then the energy inflation is likely to be subdued and that would also mean that the PCE inflation in the US would traverse below the 2% levels. That would keep the rate cuts going.
• There are important Fed speeches to be delivered by Jerome Powell, Michelle Bowman, and Raphael Bostic in the coming week. In the FOMC vote, Michelle Bowman was the only dissent vote, but clearly there would have been a larger number of members would have been ambivalent about the extent of rate cuts. These details are likely to emerge in these speeches.

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 – FED TO SUSTAIN FRONT-LOADING OF 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. For the Fed, the unemployment figure is uncomfortably high at 4.2% while the consumer inflation and the PCE inflation are now comfortably low at 2.5% and 2.2% respectively. The dissent note by Michelle Bowman was not entirely out of context and she had her strong arguments for the dissent vote. For instance, the strife in West Asia was only getting worse by the day. Even if oil prices were not rising, the trade blockages are imposing a huge cost. 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 inflationary. It is still not clear how the Fed will interpret the spike in budget deficit.

Here is a quick look at how the rate cut probabilities panned out after the PCE inflation data for August 2024 was announced on Friday. If there were some doubts about the extent of front-loading of rate cuts in the light of the strong GDP data, the 30 bps fall in PCE inflation to 2.2% has certainly made a strong case for front-loading rate cuts. Check this out.

• With the September rate cut of 50 bps done for now, the focus shifts to November and December FOMC meets. The CME Fedwatch gives a probability of 100% to 25 bps rate cut and 53.3% probability to another 50 bps rate cut by November 2024.
• What about the first milestone of December 2024? By then, another 50 bps rate cut (100 bps in all) is taken for granted. Also, there is a probability of 78.7% for an additional 75 bps rate cut. So, it could either be a 100 bps or 125 bps of rate cuts overall in the year 2024; compared to when the rate cuts started off.
• Probabilities beyond 2024 are continuously evolving and will offer more clarity once the action points for 2024 crystallize. Let us turn to June 2025 milestone. The CME Fedwatch is assigning 99.3% probability for 175 bps rate cuts from the peak and 92.2% chance for 200 bps rate cuts from the starting point of the cycle.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 96.7% probability for 200 bps of rate cuts from the peak and a high probability of 84.7% for 225 bps of rate cuts by December 2025. There is a 60.3% probability that the Fed could close year 2025 having cut rates by a full 250 bps from the starting point and moved to (2.75%-3.00%).

Will the Fed adhere to such an aggressive time table? If GDP growth figure had raised doubts, the PCE inflation at 2.2% supports front-loading. The ball has been set rolling, and the Fed would not want to stop till it is able to see tangible outcome of its efforts.