Weekly Musings – CME Fedwatch change for week to September 22, 2023

25 Sep 2023 , 09:41 AM

In the previous week, the US consumer inflation had shown a spike by 50 bps to 3.7%. That had raised expectations that the Fed may choose to front-end rates in September itself instead of waiting till November. However, when the September policy statement was announced, the Fed members resisted the temptation to opt for the easy route of rate hikes. Perhaps, the FOMC (Federal Open Markets Committee) also realizes that it does not have too much of room for further rate hikes, considering that rates are already at 22-year highs. This led to the Fed maintaining status quo on rates in the September policy. However, the Fed has given two indications in the policy statement. The first indication is that, going ahead, the hawkish strategy would mean less of rate hikes and more of prolonged pause. Secondly, the Fed has now underlined that rate cuts would be limited to just two rate cuts in 2024 as against the originally indicated four rate cuts. That was doubly hawkish.

How did all this impact the CME Fedwatch. Structurally, the CME Fedwatch has reached a state of equilibrium. Till the previous week, the CME Fedwatch was hinting at two possible rate hikes of 25 bps each and about 4-5 rate cuts in 2024. The latest policy has given a lot more clarity on the Fed future direction on rates. Hence, the CME Fedwatch has become less ambivalent and more confined to a narrower range. Now, the CME Fedwatch is assuming a worst case rate hike of 25 bps more taking the upper level possible to 5.50% to 5.75%. At the same time, the projections for interest rates for 2024 is being pegged at a worst case scenario of 4.75% to 5.00% but a most likely scenario of 5.00% to 5.25%. That also gels with the dot plot projection of the FOMC members which is pegging interest rates at an average of 5.1% towards the end of 2024. That means, there is once again a greater convergence between the views of the FOMC and the outlook expressed in the CME Fedwatch indicator. CME Fedwatch calculates probabilities of rate hikes based on the implied yields in Fed Futures trading.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED SEPTEMBER 15, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to September 15, 2023, before the above 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
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	99.0%	1.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	73.0%	26.7%	0.3%
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	61.4%	34.1%	4.5%
Jan-24	Nil	Nil	Nil	Nil	Nil	3.2%	60.0%	32.6%	4.2%
Mar-24	Nil	Nil	Nil	Nil	0.7%	15.1%	54.2%	26.6%	3.4%
May-24	Nil	Nil	Nil	0.2%	5.5%	28.2%	45.0%	18.8%	2.2%
Jun-24	Nil	Nil	0.1%	2.8%	16.8%	36.5%	32.0%	10.6%	1.1%
Jul-24	Nil	0.1%	1.6%	10.6%	27.8%	34.0%	20.0%	5.3%	0.5%
Sep-24	Nil	1.1%	7.7%	22.1%	32.0%	24.6%	10.2%	2.1%	0.2%

Data source: CME Fedwatch

The week to September 15, 2023 saw 3 important data points impacting the CME Fedwatch. Here is a quick look at the 3 key triggers for the week just gone by.

• In the previous week, Brent crude prices rallied to above $94/bbl with the US benchmark WTI prices also going above $90/bbl. This is likely to exert pressure on US inflation and make a strong case for rate hikes. For now, the oil levers are with the supply side with the demand side not being able to pull prices down.

   

• The week to September 2023 also saw consumer inflation spike by 50 bps to 3.70%, raising the spectre of a front-ended rate hike. Of course, it did not happen that way eventually but it did lead to the Fed talking a more hawkish language. The inflation reading also meant that the Fed eventually cut down on the rate cuts in 2024.

   

• The week to September 22, 2023, had positive tidings on the industrial growth front. YOY industrial output turned around from negative to positive at 0.25%, while the MOM IIP growth at 0.4% was 30 bps above forecasts. These numbers eventually gave the confidence to the Fed to hold on till November on rate hikes, despite higher inflation.

Fed officials continue to guide that rates will increase till inflation is under control. As of now, inflation is far from being in control as it has diverged 170 bps from the eventual Fed target of 2%. As Powell said, Too much versus Too little is the debate. The week to September 2023 was a week of ambivalence and that was reflected in the CME Fedwatch.

CME FEDWATCH IN THE LATEST WEEK TO SEPTEMBER 22, 2023

The week to September 22, 2023 was all about the September Fed policy statement. The statement maintained status quo on rates but the policy statement was hawkish at two levels. The Fed statement marked a shift from rate hikes to longer pause to handle the monster of inflation. That is not surprising considering that Fed rates are already at a 22-year high. The second indication was the Fed rate cuts in 2024 would be more calibrated. Fed will cut rates only twice as against 4 rate cuts that the CME Fed watch was factoring in. Both these changes have been factored into the CME Fedwatch in the latest week as the CME Fedwatch moved from being ambivalent to more certain in a confined range.

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	73.7%	26.3%	Nil
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	54.8%	38.4%	6.7%
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	53.7%	38.8%	7.5%
Mar-24	Nil	Nil	Nil	Nil	Nil	9.7%	51.0%	33.1%	6.2%
May-24	Nil	Nil	Nil	Nil	3.3%	23.9%	44.8%	23.8%	4.1%
Jun-24	Nil	Nil	Nil	1.1%	10.3%	31.0%	37.7%	17.1%	2.7%
Jul-24	Nil	Nil	0.5%	5.5%	20.2%	34.2%	27.9%	10.2%	1.4%
Sep-24	Nil	0.3%	3.3%	13.7%	28.0%	30.7%	18.0%	5.3%	0.6%
Nov-24	0.2%	1.8%	8.6%	21.0%	29.4%	24.3%	11.6%	2.9%	0.3%

Data source: CME Fedwatch

The week to September 22, 2023 saw 3 important data points impacting the CME Fedwatch. Here is a quick look at the 3 key triggers.

• The Fed statement was the real big event. Despite the 50 bps spike in consumer inflation, the fed opted to maintain status quo on rates. However, the tone was hawkish as the Fed still guided for higher than expected inflation. In addition, the Fed has also reduced the number of rate cuts it proposes in 2024. In short, the message from the Fed statement was that markets must prepare for higher rates for a longer period.

   

• The other important data point was the long term projection of growth by the Fed. For 2023 and 2024, the Fed has hiked its GDP expectation as the impact of the rate hikes on growth have been less than expected. However, higher inflation means that the rates would be well above 5% levels even by the end of year 2024.

   

• Initial jobless claims for the week were nearly 24,000 lower than expected. Strong and tight labour market has been the hallmark of the recent really and that only means that the inflation monster would be harder to tame. Strong labour data means higher wages and that largely offsets the impact of rate hikes on inflation.

For now, the CME Fedwatch has left the markets with a lot chew. Fed stays hawkish, but will be hawkish through a longer pause and fewer rate cuts next year.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

There are several triggers for the coming week. There will be two important data points in the form of the third GDP projection and the PCE inflation. However, the markets will also be focused on what the likes of Neil Kashkari (FOMC Members) say in their speeches. Broadly, there are 3 triggers to watch next week. 

• The Fed Minneapolis President, Neil Kashkari, will be speaking next week. Kashkari is known to drop important hints in his speeches about the future trajectory of rates and inflation expectations. Kashkari has generally tilted towards the more dovish side of the curve and hence his view will be crucial. Next week, in contrast, Michelle Bowman known for her hawkish view on rates will also be speaking.

   

• Two important data points this week will be the US GDP growth third estimate. In the second estimate, the June quarter GDP growth was cut to 2.1% and the pressure is likely to remain. At the same time, the core PCE inflation is likely to fall below 4% while the headline PCE inflation is likely to spike to 3.5% due to a surge in energy inflation.

   

• The big event in the coming will be the Powell speak on Thursday. His speeches carry a lot of weight as the Chairperson of the Federal Reserve. Powell take the Fed communication very seriously and is known to deliver precise assessments as well as well as honest projections about the direction of interest rates.

For now, the Fed has maintained status quo on rates, but the key data points like PCE inflation and GDP will hold the key. 

FOR INDIA, FED POLICY RAISES SOME KEY QUESTIONS

Each month, India consumer inflation (CPI inflation) and the US consumer inflation numbers are announced around the same time. This month, India inflation came in at 6.83% and the US inflation at 3.7%. There is a difference. While, inflation in the US is largely a function of higher fuel prices, in India it is more about the food inflation spike. But the reality is that both; India and the US have seen their retail inflation diverge sharply from targeted rates. The question is what it means for policy outcomes. In this policy statement, the Fed has marked a shift in inflation management from raising rates to holding rates for longer. It has also reduced the number of rate cuts in 2024 to manage inflation expectations. For India, that problem is a lot trickier since it holds the distinction of being the fastest growing large economy. The RBI would be happy for now that the US did not hike rates, but hawkishness is still hurting India and raising the risk of monetary divergence with the US Fed.

The RBI will keep a close watch on the shifts in CME Fedwatch as would the Indian financial markets. For India, the 70 bps higher US consumer inflation in last 2 months raises some serious policy challenges. For the Fed it has always been inflation and price stability first, followed by growth. However, for the RBI, the priorities are different. It cannot afford to disrupt the growth story beyond a point. However, behind the veneer of analysis, the ground reality is that monetary divergence cannot be sustained for too long by India as it would manifest in the form of shocks in the bond and currency markets. RBI can breath easy with the US maintaining status quo on rates, but PCE inflation will hold the key.