Weekly Musings – CME Fedwatch change for week to January 19, 2024

24 Jan 2024 , 09:52 AM

CME FEDWATCH TAKES 2 STEPS CLOSER TO THE FED VIEW

This has happened so often in the past. The Fed expresses a point of view, and even gives out the guidance. However, the CME Fedwatch gives an entirely different interpretation to it. It was only in the recent occasion that the dichotomy was very huge. For instance, when the Fed first hinted at rate cuts in the December policy statement, it had given guidance of 3 rate cuts of 75 bps in 2024 and another 4 rate cuts of 100 bps in 2025. However, the CME Fedwatch was a lot more aggressive and it had pegged that the Fed would implement the entire 175 bps of rate cuts in 2024 itself. That is the dichotomy that has sustained over the last 4 weeks. Things changed drastically in the latest week to January 19, 2024.

The current week trends come in the aftermath of the 30 bps rise in consumer inflation announced in the previous week at 3.40%. Fed had expressed concerns that inflation had shot up 140 bps over the target rate of 2%. The Fed also indicated in the minutes that it was not considering rate cuts immediately and did not even bother to indicate any timetable for rate cuts. The last straw on the camel’s back came this week when Fed speak by the members of the Fed was clearly in favour of a less dovish (actually more hawkish) approach to monetary policy. The message was that the Fed could not afford to turn dovish when the inflation was still 140 bps above the target level. The result was that the CME Fedwatch estimates of rate cuts for 2024 fell sharply from 175 bps to just 125 bps.

WHAT GITA GOPINATH SAID AT DAVOS

Addressing the audience at Davos, IMF chief economist, Gita Gopinath underlined that the market was being overly optimistic about rate cuts when there was no real base case for aggressive rate cuts. Gopinath also underlined that the Fed policy would be purely driven by price stability and managing inflation expectations. The priority now would be to keep rates at elevated levels and expecting massive rate cuts in 2024 was just about impractical. 

Gopinath was obviously referring to the exuberance in the CME Fedwatch, which was expecting the Fed to front-end the entire 175 bps of rate cuts in year 2024 itself. According to Gopinath, inflation had been moderated but the Fed was yet to come to grips with inflation. That was already a tough task and the situation has worsened by the Red Sea crisis, which threatens to keep oil on the boil. That led to CME Fedwatch moderating.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JANUARY 12, 2024

Just as the CME Fedwatch veered towards a more aggressive approach to rate cuts, the Fed minutes were a disappointment. While the Fed, at that point, had just factored in 3 rate cuts by end of 2024, and 4 by end of 2024, the CME Fedwatch had already factored in up to 7 rate cuts by the end of 2024 itself. In addition, the CME Fedwatch was also factoring in front-ending of rate cuts. Here is the CME Fedwatch reading.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	5.2%	94.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	76.9%	19.0%
May-24	Nil	Nil	Nil	Nil	Nil	0.4%	11.5%	71.0%	17.0%	Nil
Jun-24	Nil	Nil	Nil	0.1%	4.0%	30.8%	53.5%	11.5%	Nil	Nil
Jul-24	Nil	Nil	0.4%	6.0%	32.5%	50.4%	10.7%	Nil	Nil	Nil
Sep-24	Nil	0.4%	5.9%	32.0%	50.0%	11.5%	0.2%	Nil	Nil	Nil
Nov-24	0.3%	3.9%	22.5%	43.5%	25.4%	4.3%	0.1%	Nil	Nil	Nil
Dec-24	3.4%	18.8%	39.3%	29.0%	8.5%	0.9%%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

There were 3 critical triggers to watch out for in the week to January 12, 2024 with reference to CME Fedwatch. 

• The US consumer inflation (CPI) reading for December 2023 came in 30 bps higher at 3.40%. That is a good 20 bps higher than street expectations and the spike in inflation was largely driven by energy inflation. It remains to be seen how the Fed reacts to the data, but it is likely that rate cuts may be off the agenda for now. CME Fedwatch still appears to be confident of 175 bps rate cuts in 2024. After the 3.40% inflation reading, the CME Fedwatch had lowered its estimate of rate cuts for 2024 to 150 bps, but then again raised it to 175 bps. 

   

• The Atlanta Fed GDP was another data reading that disappointed in the week. The reading of Q4 GDP was estimated at 2.5%, but came in at just 2.2%. For now, the concern would only be if the GDP estimate dips below 2% for Q4 2024. Hard landing for the US economy may be off the table; but Q4-GDP growth is raising concerns.

   

• API crude stocks were again the big factor in the week. The API crude stocks had fallen by -7.418 million barrels in the previous week and was expected to fall by -1.2 million barrels in the week to January 12, 2024. However, actual fall in API crude stocks came in at -5.215 million barrels, which is likely to keep the oil prices elevated.

In the week to January 12, 2024, the consumer inflation was higher than expected and the action shifts to the PCE reading that is expected to come out in the last week of January.

 CME FEDWATCH IN THE WEEK TO JANUARY 19, 2024

The recent week to January 19, 2024 was a relatively quiet week with very few data points, other than Fed-speak. The table captures the Fed Futures probabilities.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.1%	97.9%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	46.2%	52.9%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	0.7%	33.1%	50.9%	15.2%
Jun-24	Nil	Nil	Nil	Nil	Nil	0.6%	31.8%	50.2%	16.7%	0.6%
Jul-24	Nil	Nil	Nil	Nil	0.6%	27.7%	47.8%	21.1%	2.7%	0.1%
Sep-24	Nil	Nil	Nil	0.5%	25.0%	45.8%	23.8%	4.6%	0.3%	Nil
Nov-24	Nil	Nil	0.3%	15.2%	37.4%	32.6%	12.3%	2.0%	0.1%	Nil
Dec-24	Nil	0.2%	12.2%	33.0%	33.6%	16.3%	4.1%	0.5%	Nil	Nil

Data source: CME Fedwatch

The week saw the CME Fedwatch moderate its expectations on rate cuts to just 125 bps in 2024, from  175 bps last week. Here are the key triggers for the coming week.

• Several Fed officials spoke during the week; including Waller, Bowman, Williams, and Bostic. The Fed officials were expected to provide guidance on whether the Fed really plans to cut rates in the current year and, if so, by how much. While the Fed members avoided specific guidance, the message was clear that rate cuts would start in H2-2024 and they would be much lower this week. The Fed members also hinted at the possibility of rate hikes, should inflation not come under control.

   

• The Atlanta Fed GDP was another key data point. It gives an advance estimate of Q4 GDP in the US. Last week, the market estimates of GDP for Q4 had come in lower at 2.2%. For the current week to January 19, 2024, the Atlanta GDP estimate had been raised to 2.4% and the Atlanta Fed GDP actually met that target. That means; the US economy would still be able to report 2.6% GDP growth for the full year 2023. Of course, we now need to await the Q4 first advance estimates by BEA and the final GDP estimates for the full year in April 2024

   

• Two things were also being closely watched this week; API crude inventories and the Fed balance sheet update. The Fed balance sheet was marginally lower at $7.67 trillion, j indicating that bonds worth $1.5 trillion are already unwound. That magnifies the impact of rate hikes. After API crude stocks had fallen by -5.215 million barrels in the previous week, the current week was expected to see a drawdown of -2.400 million barrels. However, the week actually saw oil crude stocks increase by +0.483 million barrels. Despite the Red Sea crisis, that should help to mollify fuel inflation.

Interestingly, in the previous week, the US bond yields spiked sharply while the US dollar index (DXY) was also slightly higher; reacting to higher inflation and hawkish Fed talk. These two variables will have to be closely tracked. 

TRIGGERS FOR CME FEDWATCH IN COMING WEEK TO JANUARY 26, 2024

There are 3 critical triggers to watch out for in the coming week to January 26, 2024 with reference to CME Fedwatch. Here are the key triggers for the coming week.

• The first advance estimate (FAE) of 2023 GDP growth will be out on Thursday. The Bloomberg peg for the Q4 GDP is at 2.0%, although the Atlanta GDP has pegged the growth rate at 2.4%. Either ways, the US economy is likely to meet its full year target of 2.6% GDP growth for 2023 overall. For the final numbers on GDP, we will have to wait for the last week of March 2024.

   

• PCE inflation will be another major trigger in the coming week, especially after the consumer inflation for December 2023 spiked by 30 bps. PCE inflation is based on personal consumption expenditure and is used as the benchmark by the Fed for its rate decisions. For December, the PCE inflation is expected to be flat at 2.6%. However, this is despite core PCE inflation tapering 20 bps for the month, indicating that PCE inflation would still be under pressure. The hints of higher implicit PCE inflation could also be seen if the personal spending rises MOM, as it is expected to happen.

   

• Apart from the API crude inventories, another important data point to watch out for in the coming week to January 26, 2024 will be the US bond yields. Last week, the bond yields in the US had spiked sharply from 3.9% to 4.14%. That was indicative of a more hawkish approach by the Fed. The US bond yields are an outcome and also a signal of how the CME Fedwatch responds. The spike the bond yields last week shows that the CEM Fedwatch estimates may be seeing lower levels of credibility.

For the week after next, the Fed policy statement on January 31, 2024 will be the big data pint to watch out. It is also expected to give the first clear and conclusive signal on how the Fed plans to deal with the benchmark rates in the year 2024.

 

CME FEDWATCH VS FED STANCE: IT LOOKS LIKE BACK TO SQUARE ONE

At least, that is what we read as the CME Fedwatch has sharply cut its estimate of rate cuts from 175 bps in 2024 to just 125 bps in 2024. There are two key takeaways here.

• On the upside, the rates increasingly look like being close to the peak than at the very peak. In recent weeks, the Fed members have emphasised that rate hike was a possible course of action. That has led to higher probabilities assigned to rates staying higher for a longer period of time.

   

• The major dichotomy is still on the downside, as the CME Fedwatch stays aggressive. However, the extent of aggressive has toned down substantially. The Fed has reconciled to 3 rate cuts in 2024 and 4 rate cuts in 2025, although it has been non-committal about the timing and time table for such rate cuts. CME Fedwatch, in the current week has toned down its rate cut expectations from 175 bps to 125 bps; but that is still substantially higher than the maximum rate cuts indicated by the Fed. It may be a case of the CME Fedwatch once again having jumped the gun on rate cuts.

At the end of the day, the Fed would still be data driven. In a volatile scenario, the Fed is still playing its cards close to its chest. One thing is clear; the Fed will not allow market pressures to force its hand or modify its thinking on policy issues!