Weekly Musings – CME Fedwatch change for week to October 06, 2023

9 Oct 2023 , 07:07 AM

CLARITY ON FED MOVE – FED AND CME FEDWATCH IN CONSENSUS

Over the last few weeks, there had been divergence of views between the rate outlook in the CME Fedwatch and the Fed statements. Effective, the last two weeks, there is greater convergence between what the Fed thinks and what the CME Fedwatch is manifesting. In its latest policy, combined with the long term macro forecasts, the Fed has made it amply clear that hawkishness will now have a new meaning. It will not be about hiking rates. Rate hikes may still happen but that would be one more rate hike at the most. 

However, as part of its hawkish strategy, the Fed is likely to hold rates at elevated levels for much longer. Not only that it will hold rates, but the Fed has also given an outlook of reduced rate cuts in the coming months. Firstly, the Fed rates will stay above 5%, even till the end of 2024. At the same time, the Fed is also likely to hold rates well above the pre-COVID levels for a longer period till inflation moves decisively towards the 2% mark. For now, the consensus is that there would be 1 or 2 rate cuts by end of 2024. Inflation is likely to return to 2% on a sustained basis only by around 2025. That is a long time away.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED SEPTEMBER 29, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to September 29, 2023, before the current week’s data points were factored in.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	81.7%	18.3%	Nil
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	64.8%	31.4%	3.8%
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	64.8%	31.4%	3.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	9.1%	60.1%	27.6%	3.3%
May-24	Nil	Nil	Nil	Nil	3.2%	27.1%	48.6%	19.0%	2.1%
Jun-24	Nil	Nil	Nil	1.2%	12.5%	35.5%	37.1%	12.4%	1.3%
Jul-24	Nil	Nil	0.6%	7.1%	24.4%	36.3%	24.3%	6.7%	0.6%
Sep-24	Nil	0.4%	4.4%	17.1%	31.3%	29.3%	14.1%	3.2%	0.3%
Nov-24	0.2%	2.5%	11.1%	24.6%	30.3%	21.3%	8.3%	1.6%	0.1%

Data source: CME Fedwatch

There were some important triggers that influenced the CME Fedwatch in the previous week. Broadly, there were 3 factors that had a strong impact on the colour of the CME Fedwatch. Of course, the broad trend was set by the Fed policy statement and the long term projections given out by the FOMC. Here are the factors that influenced in previous week.

• PCE inflation was the big data point in the previous week i.e., the last week of September. The PCE inflation for August came in at 3.5% yoy but the MOM inflation surged to 0.4%. However, it was also apparent that the inflation pressure came from higher energy prices, even as food inflation and core inflation continued to fall. This is likely to offer a justification for the continued hawkish stand of the Federal Reserve.

   

• The other major data point in the last week of September was the final estimate of Q2-GDP. The GDP estimate was retained at 2.1%, which is at par with the second estimate. This also aligns with the Fed projection of GDP growth for 2023 in the range of 2.1% to 2.2%. The Q2-GDP data underlines the fact that hard landing of the US economy may not be a challenge any longer. The Fed may have actually succeeded in managing what looked impossible a year ago: bringing down inflation and managing a soft landing.

   

• The US Fed takes its communication very seriously, which is delivered through the Fed statement, Fed minutes and the speeches delivered by various Fed members. In the last week of September 2023, key speeches were made by Jerome Powell, Neil Kashkari, and Michelle Bowman. Not surprisingly, Powell and Bowman veered more towards hawkish guidance; and we know what the new hawkish means. Neil Kashkari, on the other hand, was more inclined towards focusing on ensuring that a recession was prevented. 

The week to September 29, 2023 was the first time that the modified definition of hawkishness came into being. It now refers to a longer pause at higher levels and delayed rate cuts. That is not surprising considering that the Fed rates are already at a 22 year high.

CME FEDWATCH IN THE LATEST WEEK TO OCTOBER 06, 2023

The week to October 06, 2023 saw the CME Fedwatch largely stable during the week. The agenda has been set that the Fed will hold rates at elevated for longer and that is reflected in the CME Fedwatch also. Not much has changed in the Fedwatch probabilities between the previous week and the current week. Markets are still betting heavily that rate cuts have ended with a small likelihood of a 25 bps rate hike in November or December 2023.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	72.9%	27.1%	Nil
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	57.6%	36.7%	5.7%
Jan-24	Nil	Nil	Nil	Nil	Nil	2.4%	56.7%	35.5%	5.5%
Mar-24	Nil	Nil	Nil	Nil	0.5%	13.2%	52.5%	29.5%	4.4%
May-24	Nil	Nil	Nil	0.2%	5.1%	27.3%	44.2%	20.4%	2.8%
Jun-24	Nil	Nil	0.1%	2.3%	14.9%	34.8%	33.7%	12.6%	1.6%
Jul-24	Nil	Nil	1.3%	9.1%	25.6%	34.2%	22.4%	6.7%	0.7%
Sep-24	Nil	0.7%	5.7%	18.4%	30.4%	27.6%	13.6%	3.3%	0.3%
Nov-24	0.4%	3.2%	12.0%	24.4%	29.0%	20.6%	8.5%	1.8%	0.2%

Data source: CME Fedwatch

There were several key event in the current week to October 06, 2023. Here are the 4 broad factors that broadly influenced the direction and colour of the CME Fedwatch during the latest week. 

• A number of senior FOMC members including Jerome Powell, Patrick Harker, Michelle Bowman, Mester, Waller and Williams spoke during the week. The message appears to be almost uniform that hawkishness was still the preferred choice, but going ahead, it would be about holding rates higher and reducing rate cuts; but not about rate hikes. 

   

• There were two contrasting influences on the oil price equation. The OPEC members and Russia decided not to increase the supply cuts. That toned down the oil price. However, the API crude stocks showed a fall of 4.21 million barrels, which is nearly thrice the fall in the previous week. Overall, the signals for oil inflation were mixed.

   

• There was a sharp fall in the Fed balance sheet to $7.95 trillion of bonds during the week. Apart from the sharp fall in the week, the overall liquidity withdrawal from the financial system in the US has been $1 trillion in the last 16 months. That is likely to reduce the need to be too hawkish on rates as bond reductio magnifies tightness.

   

• The US trade deficit for August 2023 came in at $58.3 billion compared to $64.7 billion in the previous month and well below the August estimates of $62.3 billion. That is likely to be favourable for the US dollar, so expect the dollar index to rally more from here.

There was little difference between n the CME Fedwatch of the latest week and the previous two weeks. This is after the clarity on how the Fed would implement its hawkishness. Markets are pleased that US may have managed a soft landing. Obviously, the Fed would want to use its hawkish options very optimally and very prudently.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

There are several triggers for the coming week, which is likely to impact the CME Fedwatch. Here are 4 such factors to watch in the coming week to October 13, 2023. 

• The minutes of the Federal Open Markets Committee (FOMC) will be published next week, exactly 21 days after the policy statement. This is likely to provide insights on the extent the members of the Fed agree or disagree on the road ahead on rates.

   

• Consumer inflation number will be the big number to watch out for in the coming week. In the last 2 months, the US consumer inflation spiked from 3.0% to 3.7%. with some moderation in oil prices, the inflation figure is likely to taper, giving legroom to the Fed.

   

• The oil inventories reported by the American Petroleum Institute (API) will be a key factor. Last week the oil inventories in the US had fallen by 4.2 million barrels, which is well above the median of the recent weeks. That is likely to put pressure on fuel inflation, which has caused most of the inflation in recent months. This could have a bearing on the policy perspective of the Fed also.

   

• There are also going to be speeches in the week delivered by Powell, Bowman, and others. In all these cases, the speeches will offer hints on the policy guidance. However, the speeches in the week become important as they coincide with the Fed minutes, giving the members more data points to talk about.

The two big factors, of course will be consumer inflation in the US and the Fed minutes. The Fed may give more credence to the PCE inflation, but the consumer inflation, in a way, sets the agenda for the PCE inflation. 

INDIAN STANDPOINT AFTER OCTOBER MONETARY POLICY

In the latest week to October 06, 2023 the RBI announced its bi-monthly monetary policy. The RBI maintained the rates at 6.5%, which is along expected lines. However, the tone of the RBI was a lot more hawkish. Like the Fed, the RBI has also adopted a modified definition to hawkishness. The RBI had to stop rate hikes in February due to the pressure from industry bodies about rising cost of funds and falling operating margins and risk of insolvency rising among the Indian companies. That is a script, the RBI will still adhere to.

The new model of handling hawkishness suits India. It manages to trim inflation expectations, but also does not really impact the growth engine. India already holds the distinction of being the fastest growing large economy (economies with GDP more than $1 trillion). The RBI would be happy that the US did not hike rates and it would be happier that it modified the definition of hawkishness; as it suits India eminently.

Indian economy currently stands at a very delicate mid-point. The growth has shown tremendous resilience but the inflation risk is not going away in a hurry. The answer for the RBI is to balance the need to be hawkish with the need to manage a soft landing. In a sense, the Fed has made things easier for the RBI by a lot calling a top on rates. RBI is confident that the lag effect of rate hikes would be sufficient to do the job. We have to wait and watch, how this story pans out.