Weekly Musings –CME Fedwatch change for week to August 04, 2023

7 Aug 2023 , 09:15 AM

Unlike the previous week to July 28, 2023, the current week to August 04, 2023 was relatively less eventful in terms of the impact on the CME Fedwatch and the rate expectations. There was a small surprise in the form of Fitch downgrading the US debt by one notch from AAA to AA+. While Janet Yellen dismissed the move as misdirected, even leading economists questioned the logic of the move. After all, the idea of downgrade US debt when the debt ceiling was resolved and inflation was contained, was hardly a smart thing to do. But that had its impact on other markets, especially the emerging markets, which fell on fears that a US downgrade could spill over to other economies. At the same time, the jobs data was slightly mixed during the week. The rate of unemployment fell from 3.6% to 3.5%, but the number of jobs created also fell sharply, indicating that there was a subtle slowdown at the corporate level in the US.

If one were to sum up the shifts in the CME Fedwatch probabilities in the latest week to August 04, 2023, the probabilities did not change much at the centre. However, the impact was visible in the edges. Now, it looks like the worst case rate hike could just be 25 bps with the most likely situation being that rate hikes in the US are done and dusted. However, the probability of a sharp fall in rates in 2024 has been increasingly sharply in the latest week. Now, markets are betting on the rates falling to the range of 4.25% to 4.50% by the middle of 2024. Of course, that would still depend on how inflation pans out, although the triggers appear to be dovish with PCE inflation and consumer inflation trending sharply lower. In the midst of these positive new flows, rising crude oil prices remains a risk for global markets.

LONG RATE PAUSE, INSTEAD OF RATE HIKES WILL BE THE MODEL

In the July meeting of the Fed, the rates were again hiked by 25 bps. That was on the cards and has now moved the Fed rates a full 525 bps higher from 0.00%-0.25% to the current range of 5.25%-5.50%. The entire rate hikes have happened between March 2022 and July 2023. A total of 11 rate hikes were effected over 16 months, effectively hiking the rates by 525 basis points. This effectively takes the Fed rates to the highest level since 2001, which makes it a good 22-year record. However, with PCE inflation also falling to 3% and core PCE inflation to 4%, would it make sense for the Fed to still remain hawkish?

It now looks like the long pause would be the preferred model or paradigm for the Fed. Instead of hiking rates further over inflation fears, the Fed would prefer to prolong the pause at a higher level. That is now being reflected in the shift in rate hike expectations. The probabilities have shifted slightly lower. The latest week shift in CME Fedwatch is indicating at lesser probability on the  higher side and more probability on the lower side. In this week, the key events were the lag impact of PCE inflation, global growth macros and US jobs data.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JUNE 28, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week, before the above data points on jobs and global growth macros 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	0.2%	80.0%	20.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	0.1%	67.1%	29.7%	3.2%
Dec-23	Nil	Nil	Nil	Nil	Nil	8.9%	62.1%	26.2%	2.8%
Jan-24	Nil	Nil	Nil	Nil	2.4%	23.2%	52.5%	19.9%	2.0%
Mar-24	Nil	Nil	Nil	1.0%	11.1%	35.5%	38.8%	12.4%	1.2%
May-24	Nil	Nil	0.8%	8.9%	30.2%	38.1%	18.2%	3.6%	0.3%
Jun-24	Nil	0.3%	4.0%	17.3%	33.3%	30.2%	12.4%	2.3%	0.2%
Jul-24	0.20%	2.9%	13.4%	28.6%	31.1%	17.7%	5.3%	0.8%	Nil
Sep-24	2.5%	11.1%	25.2%	30.6%	20.6%	8.0%	1.8%	0.2%	Nil

Data source: CME Fedwatch

In the week prior to the latest week i.e., for the week ending July 28, 2023, there were 3 big events. The Fed policy statement announced a 25 bps rate hike with strong indications of a rate pause in the months ahead. Secondly, the first advance estimates of the GDP for the second quarter came in higher at 2.4%. The GDP growth was not only higher sequentially, but also higher than the street estimates. Thirdly, the PCE inflation came in sharply lower at 3% while the core PCE inflation came in at 4%. This is a clear indication that the overall inflation is decisively moving towards the Fed target of 2%. This had led to a sharp dovish shift in the previous two weeks and the shift got accentuated in the latest week. Let us not turn to the key shifts in the CME Fedwatch in the week to August 04, 2023.

CME FEDWATCH SHIFTS IN THE WEEK TO AUGUST 04, 2023

The week to August 04, 2023 had 3 critical data points and each had a different degree of impact on the CME Fedwatch during the week. However, most of the critical changes had been broadly factored into the CME Fedwatch in the previous week itself. The table below captures the CME Fedwatch probabilities at the close of the week to August 04, 2023.

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	0.2%	87.0%	13.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	71.8%	25.9%	2.3%
Dec-23	Nil	Nil	Nil	Nil	Nil	8.8%	66.2%	23.1%	2.0%
Jan-24	Nil	Nil	Nil	Nil	3.4%	31.3%	49.2%	14.8%	1.2%
Mar-24	Nil	Nil	Nil	2.0%	19.6%	41.7%	29.3%	6.9%	0.5%
May-24	Nil	Nil	1.9%	18.8%	40.8%	29.8%	7.9%	0.8%	Nil
Jun-24	Nil	0.9%	9.7%	28.9%	35.7%	19.7%	4.6%	0.4%	Nil
Jul-24	0.7%	7.6%	24.4%	34.1%	23.5%	8.2%	1.4%	0.1%	Nil
Sep-24	7.1%	21.7%	32.6%	25.2%	10.6%	2.5%	0.3%	Nil	Nil

Data source: CME Fedwatch

Let us now turn to the 3 factors that had an impact on the CME Fedwatch during the current week to August 04, 2023 in terms of critical announcements.

1. The first big data point was the Fitch downgrade during the week. Fitch Ratings cut US debt ratings a notch from AAA to AA+. This is the first time since 2011 that US debt ratings are being cut. Fitch blamed worsening fiscal situation and weak governance as reasons for the downgrade. However, the downgrade comes at a time when the US growth has remained robust despite the battle against inflation. Most economists have dismissed the downgrade as a non-event and that looks to be the case as even the dollar index was not impacted. The downgrade had a bigger impact on emerging markets, which saw risk-off outflows during the week. While it did look like a major event, the overall impact on the CME Fedwatch was very limited.

    

2. The second major data point was the latest unemployment data announced during the week. The unemployment rate fell from 3.6% to 3.5%, which his actually growth positive. However, the job creation fell sharply during the month, indicating that the pressure of sustained hawkishness was being felt in new job creation. Markes did interpret the fall in unemployment as a positive signal that the Fed had managed to contain inflation without impacting the growth engine of the US economy.

    

3. Finally, the global data flows were far from positive. Both the Euro Zone and China showed weaker than expected macro data. That is not great news for global demand. However, it could also mean that oil price hikes would be capped from these levels and the that would be positive for fuel inflation in the global economy.

The big takeaway for the week was that, instead of hiking rates, the Fed may look to prolong the pause on rates at higher levels. But the real lesson was that the US economy was robust and resilient, which explains why the Fitch downgrade had limited impact. Markets are convinced that the US economy has achieved the impossible trinity of sustainable growth, low inflation, and full employment. It is hardly surprising that, the Fitch downgrade appeared to convince the markets beyond a point.

 

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

The coming week has 3 important data points which will have a bearing on the CME Fedwatch. Here is a quick look at the 3 triggers for the coming week.

1. The biggest data point will be the consumer inflation or CPI inflation that will be announced on Thursday, August 10, 2023. The core CPI inflation is expected to edge lower by 10 bps and as a result, the headline consumer inflation is also expected to fall to below the 3% mark. The API crude inventories will also be a critical data point in giving a pointer towards fuel inflation.

    

2. In the coming week, FOMC members; Hartman and Bowman are expected to speak on Monday. That will be closely tracked for indications of how the Fed is likely to react to the incoming data. Most FOMC members have held on to their hawkish stance in public pronouncements, although it is likely to turn more benign this time around.

    

3. The US is expected to announce its trade data for June 2023 on August 08, 2023. The trade deficit is expected to narrow this month from $69 billion to $65 billion. That is likely to be a boost for the dollar. Lower trade deficit also means lower imported inflation for the US and that should also support a more benign approach to rates.

The big data point in the coming week will be the headline and core consumer inflation for July 2023. If the PCE inflation trend for June is any indicator, it is very likely that CPI inflation could trend lower in July. 

WHAT INDIA WILL FOCUS ON THIS WEEK?

Indian markets, as well as the RBI will keep a close watch on the shifts in the CME Fedwatch as it gives the clearest and most market-friendly picture of which way the monetary policy winds are blowing. Fed language, after the last hike in July, has tilted towards a longer pause than more rate hikes. That is good news for India and for the RBI. The RBI does not have to overly worry about monetary divergence with the US macros. India would be more than happy to see the Fed calling a top on rates after the July hike and for that it would be closely tracking the Fed members speak during the week.

However, India has its own inflation challenges to contend with. Firstly, India consumer inflation for June 2023 had bounced from 4.25% to 4.81%. Therefore, the gap advantage has more or less vanished, with US inflation falling sharply. The food inflation is expected to persist for the next two months, so July and August inflation in India is expected to trend towards 6% mark. It remains to be seen how the RBI fine tunes its language in the monetary policy next week, ahead of the inflation data. Secondly, India has a small worry on the Fitch downgrade. While the impact on the US has been fairly limited, the rupee has weakened sharply in the week and the risk-off flows look real now. That is something the RBI had not bargained for, so the primary focus would be on containing the side effects of the Fitch downgrade and ensuring the inflation does not get out of hand once again.