Weekly Musings – CME Fedwatch change for week to May 17, 2024

21 May 2024 , 08:18 AM

MICHELLE BOWMAN HIGHLIGHTS KEY INFLATION RISKS

Apart from the Fed policy statement and the Fed minutes, one more thing that usually influences the direction of monetary policy is the speeches and pronouncements by the various Fed governors. In a recent speech delivered to the Pennsylvania Bankers Association, Fed governor, Michelle Bowman highlighted that there was a strong case for monetary policy to continue to be restrictive. In recent weeks, there has been speculation on when the Fed would commence rate cuts. The consensus, as of now, is that the Fed will start cutting rates in September and implement 2 rate cuts in 2024 and probably 2 more by the middle of 2025. Not much is really known beyond that as the probabilities can be very subjective. In her speech, governor Michelle Bowman underlined that despite the progress on inflation, the last mile was proving tougher than imagined. In fact, Bowman perceived some distinct risks to inflation in the coming months. These risks are summarized here.

• The first risk to inflation that Bowman sees is that much of the tapering in inflation since the peak of 2022 was due to the automatic rectification of the supply chain constraints. Also, much of the new labour supply was handled by migration and that is not likely to add much now. That means, labour market may remain tight and wages would remain h high. Both have the potential to undermine the fight against inflation.
• The second risk that Bowman sees is on the geopolitical front. The situation in the Middle East and West Asia continues to remain fluid, especially after Iran launched retaliatory attacks on Israel. The Red Sea is already a troubled spot and global trade is hit badly due to strife in the Red Sea and near the Straits of Hormuz. Bowman believers that this could have a negative impact on oil prices and impose an inflation tax on consumers, especially in the US.
• Bowman also pointed out that since the end of 2023, there has been loosening of financial conditions to avoid the risk of a hard landing. The additional fiscal stimulus could also add momentum to demand, which could, in turn, trigger inflation to new highs. In addition, the bond book taper has also been stalled for now and that would also mean more liquidity sloshing around in the system. All these factors have the potential to spike inflation.
• Finally, there is also the risk that a combination of strong demand for consumer services and a rise in immigration could result in the return of core inflation. Most of the core sector levers have been used up and the only way core inflation can now move is up.

Bowman also pointed out that wage growth has been at 4-5%, while a rate of 2% would be more conducive with inflation control. To sum up, the end of the road for inflation control may look tantalizing close, but that could be illusory. There could still be many a slip between the cup and the lip.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED MAY 10, 2024

The week to May 10, 2024 was marked by the Fed policy statement, which remained consistent that inflation would be the sole driver of rate action. The CME Fedwatch was expecting 2 rate cuts in 2024 and 2 more by the first half of 2025, but the underlying assumption was that inflation would show genuine tapering.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	3.5%	96.5%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.8%	24.6%	74.6%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	12.2%	48.6%	38.8%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.1%	4.5%	24.9%	45.2%	25.2%
Dec-24	Nil	Nil	Nil	Nil	0.1%	2.4%	14.9%	35.3%	35.0%	12.3%
Jan-25	Nil	Nil	Nil	Nil	1.0%	7.5%	23.3%	35.2%	25.7%	7.3%
Mar-25	Nil	Nil	Nil	0.5%	4.3%	15.5%	29.3%	30.4%	16.3%	3.6%
Apr-25	Nil	Nil	0.2%	1.9%	8.3%	20.4%	29.7%	25.4%	11.9%	2.3%
Jun-25	Nil	0.1%	1.0%	5.0%	14.2%	24.9%	27.6%	18.8%	7.2%	1.2%
Jul-25	Nil	0.4%	2.3%	8.0%	17.7%	25.8%	24.7%	15.0%	5.2%	0.8%

Data source: CME Fedwatch

There were 3 triggers in the week to May 10, 2024 with reference to CME Fedwatch.

• Neil Kashkari delivered a speech that was interesting in a number of ways. Kashkari just stopped short of ruling out rate cuts in 2024 and even suggested that zero rate cuts was the most likely scenario. In the process, Kashkari did not rule out the possibility of rate hikes if inflation persisted and gave an optimistic-case scenario of 2 rate cuts in 2024.
• API crude stocks showed a spike for the second week in a row. Ironically, the oil stocks reported by the API were expected to fall by -1.430 Million barrels. Instead, rising US and Canadian output ensured that the stocks increased by +0.509 Million barrels. That helped sober oil prices and oil inflation risk in the US economy.
• Weekly update of Atlanta GDP forecast for Q2-2024 was raised by 90 bps from 3.30% to 4.20%. This is much better than what markets had anticipated. This, at least, proves that hard landing may be out of the way. However, it also implies that inflation may remain sticky amidst higher growth and wages.

Let us turn to the major triggers for the CME Fedwatch in the latest week to May 17, 2024, in terms of key macro data pronouncements.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO MAY 17, 2024

The latest week to May 17, 2024 saw the CME Fedwatch continuing to presume just 2 rate cut in 2024; with rather volatile probabilities. However, the 10 bps lower CPI inflation did make the probabilities of CME Fedwatch slightly more optimistic.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.9%	91.1%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.0%	27.6%	70.4%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	14.8%	49.0%	35.2%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.4%	5.9%	26.8%	44.1%	22.8%
Dec-24	Nil	Nil	Nil	Nil	0.2%	3.4%	17.4%	36.3%	32.4%	10.3%
Jan-25	Nil	Nil	Nil	0.1%	1.5%	9.0%	24.9%	34.8%	23.6%	6.2%
Mar-25	Nil	Nil	Nil	0.8%	5.6%	17.7%	30.3%	18.7%	14.1%	2.8%
Apr-25	Nil	Nil	0.4%	2.7%	10.3%	22.7%	29.7%	22.9%	9.6%	1.7%
Jun-25	Nil	0.2%	1.6%	6.8%	16.9%	26.4%	26.1%	15.8%	5.4%	0.8%
Jul-25	0.1%	0.7%	3.6%	10.7%	20.6%	26.3%	22.1%	11.8%	3.6%	0.5%

Data source: CME Fedwatch

There were 3 critical triggers in the latest week to May 17, 2024 with reference to the swings in the CME Fedwatch.

• The CPI inflation in the US was announced during the week. As per Bloomberg estimates, the headline consumer inflation was supposed to taper by 10 bps from 3.5% to 3.4% and that is precisely what happened. Even the MOM inflation came in lower than expected. However, this was a small fall after some large spikes in recent months. Also, the inflation is still a full 140 bps away from the eventual target of 2%.
• There were 2 key speeches in the week. Jerome Powell continued to paint an optimistic picture assuring the markets that the next rate move would not be on the upside. He also made markets more comfortable with the “higher for longer” logic. On the other hand, Michelle Bowman, warned that the best of inflation tapering may be done and now the upside risks were more than the downside potential. Bowman clearly did not see rate cuts by the Fed in the near future.
• Oil inflation risks were back to haunt this week after the inventory drawdown was much sharper than expected this week. From +0.509 Million barrels increase last week, the oil inventories were expected to draw down by -1.350 Million barrels. However, the drawdown was much higher at -3.104 Million barrels. Oil inflation risk is not going away in a hurry.

Let us finally turn to the outlook for interest rates in rest of 2024 and what the CME Fedwatch is indicating about the direction and the timing of rate cuts; if any.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO MAY 24, 2024

There are 3 critical triggers to watch out for in the coming week to May 24, 2024 with reference to CME Fedwatch.

• The big announcement next would be the FOMC minutes on Wednesday, May 22, 2024. In the policy statement on May 01, 2024, the Fed had held status quo on rates, which hinting that it would tread cautiously on rate cuts. In the minutes, the markets will be looking at a firm time table, if the Fed plans to cut rates starting September; as the CME Fedwatch has been indicating for some time. Greater policy clarity will be expected.
• Again, there are some big speeches coming up in this week. Jerome Powell is expected to speak during the week, apart from other governors like Mester, Bostic, Krozner and Waller. Apart from the governors, Treasury Secretary, Janet Yellen will also be speaking during the week while vice chair of the Federal Reserve, Barr will also be a speaker. The markets will look to decipher the future course from the FOMC minutes and speeches.
• There will be two more key data points this week. In the latest week, the initial jobless claims are likely to come down from 222K to 221K, while the Atlanta Fed GDP estimate is likely to be at around 3.6%. The signs are still of a robust economy and that is why this data is critical. As long as growth and demand are robust, rate cuts look unlikely.

Let us finally turn to the outlook for interest rates in the year 2024 and what the CME Fedwatch is indicating about the direction and the timing of rate cuts; if any.

CME FEDWATCH PENCILS JUST TWO RATE CUTS IN 2024

There has been some interesting change in the latest week to May 17, 2024. As of the end of this week, the CME Fedwatch is pencilling in a 57% probability (up from 53% last week), that the Fed would cut rates by 50 bps in year 2024. This is higher than just one rate cut pencilled two weeks back. The first rate cut is most likely to happen in September, with one more rate cuts in November or in December. However, that would predicate on the willingness of the hawks inside the Fed to give up on the “higher for longer” safety net. As of date, there is no credible evidence that inflation was moving towards the target of 2%.

• What about the probabilities on the upside? After the GDP data and the PCE inflation data in the last week of April, there was a brief period when the CME Fedwatch anticipated a rate hike in 2024. However, with Jerome Powell underlining that the next move would be downward, the CME Fedwatch has discounted any rate hike possibility. For now, there are members who are still mooting that idea, but Powell may not be keen to support such an idea due to its larger implications for growth.
• The projection still stays at 2 rate cuts in 2024. However, the probabilities are looking a little more optimistic on the downside, after the CPI inflation came in lower at 3.4% for April 2024. The CME Fedwatch is pencilling in one rate cut in September and one more rate cut in December 2024; but that is assuming that inflation cooperates. In addition, the CME Fedwatch is also pencilling a third rate cut by April and the fourth rate cut by July 2025. Effectively, we could have 4 rate cuts by middle of 2025 and the Fed rates, at that point would stand in the range of 4.25% to 4.50%.

The hawks within the Fed believe that it is better to be safe than sorry, and hence the defensive approach. It is true that the inflation damage may be hard to undo, if rate cuts trigger inflation. The Fed has not given any guidance on the number of rate cuts, but the markets would be more than pleased if the first rate cut happens in September 2024. Till that time, it will continue to be a delicate balancing game!