Weekly Musings – How CME Fedwatch changed for the week ended May 26, 2023

29 May 2023 , 07:37 AM

These probabilities are culled from the fed futures trading data. What has been the big driver of the shift in the CME Fedwatch during the week ended 26^th May 2023? Broadly, there have been 3 key macro data points at play.

What impacted the CME Fedwatch probabilities in the week?

For the week ended 26^th May 2023, the first major item of impact was the Fed minutes announced earlier this week. Broadly, the minutes maintained the stance that inflation was falling slower than expected and hence rate hikes may have to continue. However, the FOMC was sharply split on the rate hike trajectory and now the consensus appears to be that the Fed may pause in June. The other major data point was the second estimate of Q1CY23 GDP at 1.3%. That is a 20 bps upgrade from the first estimate, but still sharply lower than the Q4CY22 growth rate of 2.6%. Growth remains a key concern for the Fed to handle and the minutes also spoke about an impending recession in the fourth quarter. Finally, there was the PCE inflation (the input for Fed rates) that grew 0.4% on a MOM basis. This is indicative of the fact that inflation continues to be sticky. It was the combination of these 3 factors that determined the movement in CME Fedwatch during the week to 26th May.

Recap – CME  Fedwatch for the week ended 19th May

Here is a quick recap of how the CME Fedwatch looked like for the previous week, before the above data points were factored in.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550
Jun-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	82.6%	17.4%
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	80.6%	19.4%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	29.0%	58.4%	12.6%
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	22.5%	51.8%	22.7%	3.1%
Dec-23	Nil	Nil	Nil	Nil	Nil	17.1%	44.7%	29.7%	7.7%	0.8%
Jan-24	Nil	Nil	Nil	Nil	13.8%	39.4%	32.6%	12.0%	2.1%	0.2%
Mar-24	Nil	Nil	Nil	12.1%	36.3%	33.4%	14.5%	3.3%	0.4%	Nil
May-24	Nil	1.7%	15.4%	35.9%	30.8%	12.9%	2.9%	0.3%	Nil	Nil
Jun-24	0.9%	9.3%	26.9%	33.1%	20.8%	7.3%	1.5%	0.2%	Nil	Nil

Data source: CME Fedwatch

What did the CME Fedwatch for the previous week ended 19th May depict? It clearly showed that the markets were betting on a best case rate hike of another 25 bps and a worse case rate hike of another 50 bps from current levels. More importantly, the markets have toned down their expectations of rate cuts, at least in the year 2023. Despite the affirmation from the Fed that there would not be any rate cut in 2022, the markets were still betting on a 50 bps rate cut in the year 2023. Let us now turn to how the CME Fedwatch changed in the current week ended 26^th May 2023, based on the 3 key triggers viz., publication of Fed minutes, second estimate of Q1GDP growth and PCE inflation April 2023.

CME Fedwatch for the latest week ending 26th May

Let us now look at how the CME Fedwatch looked as of the latest week i.e., the period ending 26^th of May 2023.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575
Jun-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	35.8%	64.2%	Nil
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	20.7%	52.2%	27.1%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	4.5%	27.6%	46.7%	21.1%
Nov-23	Nil	Nil	Nil	Nil	Nil	2.4%	16.6%	37.6%	33.3%	10.0%
Dec-23	Nil	Nil	Nil	Nil	1.2%	9.7%	27.5%	35.4%	21.3%	4.9%
Jan-24	Nil	Nil	Nil	0.8%	6.7%	21.1%	32.5%	26.4%	10.8%	1.8%
Mar-24	Nil	Nil	0.6%	5.3%	17.6%	29.8%	27.9%	14.5%	3.9%	0.4%
May-24	Nil	0.8%	5.8%	18.2%	29.7%	27.3%	14.1%	3.8%	0.4%	Nil
Jun-24	0.5%	3.8%	13.1%	25.0%	28.3%	19.5%	8.0%	1.8%	0.2%	Nil

Data source: CME Fedwatch

If we were to summarize the weekly shift in just one sentence, the markets have turned hawkish in the short term and are reconciling to the possibility that the Fed may not cut rates in 2023 at all. Just one data points summarizes this position. In the previous week, the Fedwatch showed an 82.6% probability that the Fed would maintain status quo in June policy. However, in the current week, the markets are assigning just 35.8% probability to status quo and has assigned probability of 64.2%  for a 25 bps rate hike in June policy.

As we stated earlier, the CME Fedwatch captures rate shift probabilities based on actual Fed futures trading data. So, what has made the markets more hawkish in the last one week. Even as the Fed minutes hinted at a pause in June, two macro data points suggest the contrary. The upgrade to Q1 GDP growth and the 40 bps higher sequential PCE inflation raised concerns of a rate hike in June. Now, the markets are also assigning higher probability to a 50 bps rate hike from here, and expect rates to stabilize in the 5.50% to 5.75% range.

What changed for the CME Fedwatch in the latest week

A week is a long time in the markets and that was best evidenced in the latest week to 26th May 2023. The undertone of the markets appears to have changed sharply in the last one week. Here is how.

1. During the passage of the last one week, 3 major data points influenced the shift. Firstly, the Fed minutes indicated that members were split about the future trajectory of rates. While none of the members were in a hurry to cut the rates, the perception is that the higher than expected PCE inflation and the upgrade to the Q1 GDP estimates should be a fit case for the Fed to stay hawkish and focus on inflation control for longer periods.

    

2. Another major shift during the latest week is the way the perception of peak rates changed. In the previous week, the markets were betting that the Fed rates should peak around the range of 5.25% to 5.50%, which is 25 bps higher from current levels. However, after the PCE inflation data and the GDP data, the markets are willing to bet on 50 bps higher peak rates from the current levels.

    

3. The third major shift in the week was on the expectations of rate cuts in the coming months. In the previous week ended 19th May, the  CME Fedwatch expectation was of a 75-100 bps rate cut by end of 2023 and 175 bps rate cut over the next one year. That has suddenly changed to a 25 bps rate cut in 2023 and a 75 bps rate cut at the most in the next one year. Also, the probability that the rates may remain around the current levels for much longer has also increased in the last one week.

    

4. To sum it up, the markets appear to veering more towards the Fed point of view, instead of adopting a contrasting view, as it did in the last couple of months. One thing is certain that the banking crisis may end up reducing the need to hike rates too much as it has already led to tight credit conditions. June could possibly be a pause but it would come with a strong message that rates will be still headed higher to check inflation. Even Fed has indicated that the central bank may be close to the terminal rate but inflation continues to be an unknown X-factor amidst the strong labour data.

Between now and the next couple of weeks, an important factor impacting the Fedwatch probabilities will be the debt ceiling debate. The US Treasury can at best function up to 05^th  June without needing to hike the debt ceiling; not after that. What actually happens on the debt ceiling will be the key influence on the CME Fedwatch expectations in the coming week.