Weekly Musings – CME Fedwatch change for week to February 23, 2024

26 Feb 2024 , 06:46 AM

FED MINUTES CONVERGES CME FEDWATCH AND FED VIEWPOINT

A few weeks back, there was a lot of aggression in the CME Fedwatch. Against the Fed guidance of 3 rate cuts in 2024 and 4 rate cuts in 2025, the CME Fedwatch had pegged full 7 rate cuts of 175 bps in 2024 itself. Over the last few weeks, it was a return to sanity for the CME Fedwatch and the latest week saw the circle complete in terms of convergence. Here is what the Fed minutes said and here is why the CME Fedwatch converged eventually.

• In the minutes of the FOMC Jan-31 meet, it emerged that the Fed was concerned about the pace of growth in GDP, and its likely impact on inflation. For the fourth quarter of 2023, the first advance estimates of GDP growth stood at 3.3%, while the Atlanta Fed GDP projections for Q1-2024 is at over 4%. Fed officials are naturally concerned that at such elevated levels of GDP growth, inflation may be very tough to rein in.

   

• The FOMC underlined in the minutes that it would want to see more concrete evidence of inflation coming down in a sustainable manner. The core inflation indicator has been falling, but in January 2024, the core inflation stagnated at 3.7%. Also, while food inflation trended lower, the impact of the Red Sea crisis on oil inflation is still not too explicit and as of now, the risk is still evolving. 

   

• FOMC minutes clearly underscored that it would be loath to cutting the rates or, even indicating rate cut time table, until and unless the FOMC gained greater confidence that inflation was moving sustainably toward 2%. This can certainly be interpreted as a cautious move, but it also be an indication that rates may have peaked out; and rate hikes were off the table for the time being. That could be the good news.

   

• The Fed has already scaled down its balance sheet by close to $1.50 Trillion since the post-COVID peak. The minutes have stated that the Fed may now go slow on its bond book taper. It may still want to bring the book down to the pre-COVID level of $4.5 Trillion, but that may now happen in a more calibrated manner, such that domestic liquidity does not become too tight.

Overall, the minutes of the FOMC underlined that the last mile of rate cut action could be the toughest part and they would not want to take the risk of being too early to cut rates, especially considering its downside risks to inflation in the US economy.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED FEBRUARY 16, 2024

The week to February 16, 2024 did not have key data points and the CME Fedwatch movement was largely based on speeches made by Fed members, which continued to be cautious and veering towards hawkishness. Even the trajectory of the US bond yields and the dollar index did not reveal much. The CME Fedwatch appears to be reconciling to the reality of just about 75-100 bps of rate cuts in the current calendar year and a more aggressive stance in 2025. For now, the only signal is that, rate cuts are off the table in March and the first rate cuts would only happen in June 2024, or later. 

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.0%	90.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	3.2%	35.2%	61.6%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	2.2%	25.7%	53.7%	18.4%
Jul-24	Nil	Nil	Nil	Nil	Nil	1.6%	18.7%	45.4%	28.9%	5.5%
Sep-24	Nil	Nil	Nil	Nil	1.2%	14.9%	39.5%	32.5%	10.6%	1.2%
Nov-24	Nil	Nil	Nil	0.7%	8.7%	28.4%	35.7%	20.5%	5.4%	0.5%
Dec-24	Nil	Nil	0.5%	6.6%	23.2%	33.7%	24.5%	9.5%	1.9%	0.1%
Jan-25	Nil	0.3%	4.1%	16.5%	29.5%	28.2%	15.5%	4.9%	0.8%	0.1%
Mar-25	0.1%	1.9%	9.2%	21.9%	29.0%	23.0%	11.1%	3.2%	0.5%	Nil
Apr-25	1.7%	6.5%	17.2%	26.3%	25.2%	15.6%	6.2%	1.5%	0.2%	Nil

Data source: CME Fedwatch

There had been 4 critical triggers in the week to February 16, 2024 with reference to CME Fedwatch. Consumer inflation was the big data point.

• The US consumer inflation for January 2024 came in at 3.1%. This was sequentially lower than December 2023 reading of 3.4%, but higher than the Bloomberg consensus estimate of 2.9%. That raised the likelihood that the Fed would delay rate cuts beyond May and June, to ensure that last mile inflation is properly reined in.

   

• The Federal budget deficit for January was announced on Monday. The budget deficit for the month came in at $22.0 Billion, which is much lower than street estimates of $39 Billion. This was one factor that helped the dollar to harden in that week.

   

• The industrial output growth made an ambivalent statement on GDP signals. Both, the MOM and YOY growth in industrial output were expected to surprise on the upside. However, while YOY IIP was in line, MOM IIP came in at -0.1%, against expected +0.2%.

In terms of Fed speak, most of the speakers during the week continued to remain cautious about the likely trajectory of when the Fed would commence rate cuts. That remains the X-factor for now.

CME FEDWATCH IN THE WEEK TO FEBRUARY 23, 2024

The recent week to February 23, 2024 was all about the Fed minutes announcement, which only appeared to underline the Fed caution. The table below captures the Fed Futures probabilities over the next 10 meetings of the Federal Open Markets Committee (FOMC) at the close of the week. The expectation is 75 bps rate cut by December 2024 and a total of 100 to 125 bps by April 2025. That is what the Fed had maintained, all along.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.0%	96.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.9%	25.3%	73.8%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	0.5%	14.3%	52.0%	33.1%
Jul-24	Nil	Nil	Nil	Nil	Nil	0.3%	8.2%	35.4%	41.5%	14.7%
Sep-24	Nil	Nil	Nil	Nil	0.2%	5.7%	26.7%	39.5%	23.2%	4.7%
Nov-24	Nil	Nil	Nil	0.1%	2.9%	16.2%	33.1%	31.4%	14.0%	2.3%
Dec-24	Nil	Nil	0.1%	2.0%	11.7%	27.4%	32.0%	19.8%	6.2%	0.8%
Jan-25	Nil	Nil	1.2%	7.6%	20.8%	30.0%	25.0%	12.0%	3.1%	0.3%
Mar-25	Nil	0.5%	3.6%	12.5%	24.2%	28.1%	20.1%	8.7%	2.1%	0.2%
Apr-25	0.3%	2.4%	9.2%	19.9%	26.7%	23.1%	13.0%	4.5%	0.9%	0.1%

Data source: CME Fedwatch

There were 4 critical triggers in the week to February 23, 2024 for the CME Fedwatch, with the Fed minutes obviously being the most critical.

• The Fed published its FOMC minutes during the week, with the ambivalence on the timing of the rate cuts continuing. Fed continued to reiterate that it would still want to see convincing evidence of inflation moving towards 2%. Now it looks like even May rate cuts may look unlikely and June is when rate cuts could actually begin.

   

• The API (American Petroleum Institute) crude stocks were encouraging. The API crude stocks increased by 7.168 Million barrels; higher than the estimate of 4.298 Million barrels. However, it was lower than the previous week at 8.520 Million barrels.

   

• All eyes will be on the Fed balance sheet. The Fed minutes had indicated that it would reduce the usage of the bond taper to ensure sufficient liquidity in the system. However, this weed did see the Fed balance sheet tapering lower to $7.582 Billion.

   

• During the week, there were important speeches made by Fed governors, Raphael Bostic, Michelle Bowman, Chris Waller, and Neil Kashkari. The undertone in all these cases was one of caution on rate cuts and an unwillingness to jump into rate cuts too early, lest it spike inflation in the US.

The coming week will have several important data points impacting the CME Fedwatch.

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO MARCH 01, 2024

There are 4 critical triggers to watch out for in the coming week to February 23, 2024 with reference to CME Fedwatch. The big trigger will be the Fed minutes publication.

• The Q4 GDP second estimate will be out on Wednesday and it is expected to remain static at 3.3%, the same level as the first advance estimate. That still holds the promise of full year GDP for 2023 at well above the 2.2% mark. Atlanta Fed GDP for Q1-2024 is expected to be robust at 2.9% in the coming week.

   

• The US BEA will also announce the PCE (private consumption expenditure) inflation in the coming week, which is the input used by the Fed to take a call on rate action. PCE inflation was pegged at 2.6% in December 2023 and the indications are that it could inch up marginally by 10-20 bps, especially if you look at cues from the MOM data.

   

• All eyes will be on the Fed balance sheet. It had tapered last week to $7.58 Billion after being steady for 2 weeks. However, it remains to be seen as to what happens to the taper, since the Fed minutes have clearly indicated that they would go slow on taper for the time being to keep liquidity comfortable.

   

• The week will also have its share of important views coming from the Fed governors like John Williams, Raphael Bostic and Loretta Mester are likely to speak this week. We have not been getting any contrarian signals in the recent weeks from any of the governors, with most of them aligned to the “Higher for Longer” point of view.

Let us finally turn to how the CME Fedwatch has eventually converged towards the Fed point of view.

CME FEDWATCH VS FED STANCE: FINALLY, IT IS CONVERGENCE

Last week, the CME Fedwatch further had cut its estimate of rate cuts from 175 bps in 2024 to just 75-100 bps in 2024. This week after the Fed minutes were announced, the CME Fedwatch is left indicating a 75 bps rate cut in 2024, exactly what the Fed had stated. As usual, the Fed takes its communication very seriously and it has always detested a situation when the market tries to second-guess its statements. The Fed does what it says. There are 2 key takeaways in terms of the divergence between CME Fedwatch and the Fed stance.

• On the upside, there appears to be a consensus between the Fed and the CME Fedwatch on rates trajectory. Even the Fed has now almost committed that rates had topped out at 5.25%-5.50%. The minutes of the Fed were testimony to that shift. One thing is clear; additional rate hikes will only happen under very exceptional circumstances. In a tough situation, the first preference for the Fed would be to hold rates higher for longer rather than hiking rates. The Fed and the CME Fedwatch are in perfect sync on the upside.

   

• Now, they are also in sync on the downside. The dichotomy was on the downside, but that reduced to zero this week. The aggression of the CME Fedwatch had been toning down in recent weeks. The Fed had originally committed to 3 rate cuts in 2024 and 4 rate cuts in 2025, without any time table for rate cuts. The CME Fedwatch started off pegging that 175 bps rate cut would happen in 2024 itself. Now, the CME Fedwatch has pegged 75 bps rate cut by December 2024 and 100 bps to 125 bps by April 2025.

The Fed had reiterated, time and again, that It would stay data driven and would even prefer to err on the side of caution. Fed has consistently underlined that the last mile inflation was the toughest to handle for the policymakers. For now, the Fed stays ambivalent about the trajectory and the timing of rate cuts. Fed wanted to prove a point that; it will not allow market pressures to force its hand. That has been achieved. For the Fed, it continues to be price stability and full employment over GDP growth. This week, the CME Fedwatch has finally veered around to what the Fed has been saying all along!