Weekly Musings – CME Fedwatch change for week to August 18, 2023

20 Aug 2023 , 09:01 AM

Like the previous week, even the latest week to August 18, 2023 was relatively less eventful in terms of the impact on the CME Fedwatch and the rate expectations. Also, the expectations appear to have largely stabilized. The markets are expecting a strong likelihood of 25 bps rate hike and a very strong possibility of 2-3 rate hikes if inflation was not reined in. The markets are not expecting any rate cuts in 2023. Additionally, the proposed rate cuts in 2024 are also likely to be for 75 to 100 bps at the maximum, nothing more. 

For the week, CME Fedwatch reacted to 3 key pieces of data flows. The first data point was the hawkish tone of the FOMC minutes of the July Fed meeting. Secondly, while speaking at Minneapolis, FOMC member, Neil Kashkari, voiced similar sentiments and underlined that he was unwilling to commit that rate hikes were done, till it was ratified by inflation at 2% on a sustained basis. Lastly, oil inventories fell much sharper than expected, indicating that fuel inflation was likely to haunt for some more time.

If one were to sum up the shifts in the CME Fedwatch probabilities in the latest week to August 18, 2023, the probabilities did not change much at the centre. However, the impact was visible in both the sides. It does look like the next rate hike could be 25 bps with an outside possibility of 50 bps rate hike. However, markets are ruling out any rate hikes in the September 2023 FOMC meeting. At a broader level markets are reconciled to no rate cuts till March 2024 and, anyways, the rate cuts would be about 100 bps over one year. 

FROM LONG PAUSE TO FRONT ENDING HAWKISHNESS

After the Fed rates were hiked by 25 bps in the July policy, the general expectation was of a long pause rather than further rate hikes. In fact, the expectation was that the long pause would be used as a proxy for hawkishness. If you go by the recent indications coming from the FOMC minutes and the speech by Neil Kashkari, it looks like long pause is ruled out. Instead, the Fed may prefer to front-end rate one or two more rate hikes and ensure that inflation gravitates quickly towards the 2% mark. Fed rates are currently in the range of 5.25%-5.50% after 11 rate hikes in 16 months and this marks the highest level of Fed rates since 2001. 

If you combine the tone of the FOMC minutes with the recent speech by Neil Kashkari, the message is that long pause is not a strategy being seriously considered. The Fed would prefer to front-end rate hikes in this year and get done with it. That is what even the CME Fedwatch is indicating; wherein, another rate hike in November or December would probably mark the peak of rates. We must wait and watch.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED AUGUST 11, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week, before the above data points on FOMC minutes and Kashkari speak were out.

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	90.0%	10.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	63.1%	33.9%	3.0%
Dec-23	Nil	Nil	Nil	Nil	Nil	8.1%	59.3%	29.9%	2.6%
Jan-24	Nil	Nil	Nil	Nil	2.5%	24.0%	50.2%	21.5%	1.8%
Mar-24	Nil	Nil	Nil	1.2%	12.8%	36.6%	36.4%	12.0%	0.9%
May-24	Nil	Nil	1.0%	10.7%	32.2%	36.4%	16.5%	3.0%	0.2
Jun-24	Nil	0.5%	5.5%	20.6%	34.2%	27.3%	10.3%	1.7%	0.1%
Jul-24	0.3%	4.2%	16.7%	30.7%	29.0%	14.6%	3.9%	0.5%	Nil
Sep-24	3.7%	14.2%	27.9%	29.4%	17.5%	6.0%	1.2%	0.1%	Nil

Data source: CME Fedwatch

Let us turn to the 3 factors that had an impact on the CME Fedwatch during the week to August 11, 2023.

• US consumer inflation announced in the previous week for July 2023 had come in 20 bps higher at 3.2% compared to 3% in June. That was paradoxical sine PCE inflation had also fallen to 3% in June. With the Fed now 120 bps away from its inflation target, another rate hike is being factored in the CME Fedwatch.

   

• The second data point was Michelle Bowman speak. Bowman is known to be ultra-hawkish and she almost underlined that one more rate hike was inevitable with the possibility of even two rate hikes. She had hinted at terminal rates of up to 6%. 

   

• Moody’s followed up the Fitch debt downgrade with a downgrade of small and medium US banks. This could act as a tightening strategy. This is likely to make banks credit-wary as banks prefer to preserve capital. This could tighten credit availability for consumers.

In the previous week to August 11, 2023, the CME Fedwatch gave the first indications that rates could go as high as 6% in the current year. The long pause argument has been almost dismissed now. The hope is that the bank downgrade could have a soothing effect on the Fed as the credit tightening would act as a proxy for a rate hikes. 

 

HOW CME FEDWATCH SHIFTED IN THE WEEK TO AUGUST 18, 2023

The week to August 18, 2023 had 3 critical data points with a different degree of impact on the CME Fedwatch. There was the FOMC minutes announcement, the speech by Neil Kashkari and the sharp fall in US oil inventories. Here is how the impact could be felt.

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	89.0%	11.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	63.9%	33.0%	3.1%
Dec-23	Nil	Nil	Nil	Nil	Nil	8.6%	59.7%	29.0%	2.7%
Jan-24	Nil	Nil	Nil	Nil	2.1%	21.3%	52.1%	22.5%	2.0%
Mar-24	Nil	Nil	Nil	0.9%	10.2%	34.2%	39.7%	13.9%	1.2%
May-24	Nil	Nil	0.5%	5.6%	22.4%	37.0%	26.5%	7.4%	0.6
Jun-24	Nil	0.3%	3.8%	16.5%	31.9%	30.2%	14.1%	3.0%	0.2%
Jul-24	0.2%	2.8%	12.7%	27.3%	30.7%	18.9%	6.3%	1.0%	0.1%
Sep-24	2.3%	10.1%	23.5%	29.8%	22.0%	9.6%	2.4%	0.3%	Nil

Data source: CME Fedwatch

Let us turn to the 3 factors that had an impact on the CME Fedwatch during the current week to August 18, 2023.

• FOMC minutes announced in the latest week was quite emphatic that more needs to be done to rein in inflation. After 525 bps of rate hikes, the inflation is still 120 bps away from its 2% target. The FOMC minutes made it clear that there was no relenting on inflation control and also there was no question of long pause. It would be front-ending of rate hikes to rein in inflation.

   

• In his speech in Minneapolis, Neil Kashkari underlined that it was tough to call the top on rates. There was really no target and the only target was to rein in inflation to 2%, whatever it takes. That means, logically, the rate hikes could even extend into 2024, delaying rate cuts even further.

   

• Finally, the oil inventories data put out by the American Petroleum Institute (API) has underlined a sharp fall in US oil inventories. This is likely to accretive to oil prices and become a trigger for fuel inflation. That would make the Fed more steadfast in hiking rates further to contain inflation. In short, the message is hawkishness will prevail till inflation is brought down in a sustainable manner.

When it comes to CME Fedwatch, a lot changes in a few weeks. From betting on a long pause, the CME Fedwatch has shifted to one or two more rate hike before a long pause. Rate cuts are not even being considered as of now. It remains to be seen how much the bank downgrades and asset taper will help reduce the strain on rate hikes.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

The coming week has 4 important data points which will have a bearing on the CME Fedwatch. Here is a quick look at the 4 triggers for the coming week.

1. FOMC member, Michelle Bowman, speaks during the week and she has normally tilted towards a very hawkish approach to rates. At a time when the general sentiments are veering towards more rate hikes, Bowman should only add to the hawkish narrative.

    

2. Apart from Bowman, even Jerome Powell is expected to speak in the week. Powell takes his communication very seriously as the representative of the Federal Reserve and he likely to communicate an ambivalent message. Unlike Bowman, Jerome Powell is likely to veer more towards trying to find a middle path for monetary policy.

    

3. The all-important Jackson Hole Symposium will happen this week. It comes at a time when the heads of major central banks need to agree on global policy initiatives on managing inflation and liquidity. Currently, there is still too much of monetary divergence and hopefully the Jackson Hole Symposium should enable the top central bank leaders to talk in a synchronized language.

    

4. Finally, the markets will also watch out for data on the Fed Balance Sheet this week. The Fed balance sheet has already contracted from a peak of $9.10 trillion to $8.15 trillion without impacting liquidity. However, this is likely to be used as a proxy for rate hikes and that could be the interesting part of the story.

Markets are veering around to the view that bank downgrade by Moody’s and the Fed balance sheet reduction should act as a substitute for rate hikes by the Fed in future. We need to here the Fed narrative on this issue.

WHAT INDIA WILL FOCUS ON THIS WEEK?

Indian markets, as well as RBI keep a close watch on the shifts in the CME Fedwatch as it gives the perfect market reflection of which way the monetary winds are blowing. For India, the higher US inflation did come as a temporary relief. However, with Indian consumer inflation coming in at 7.44% for July 2023, there is not much to relish about. The RBI may have to quickly take a decision on rate hikes; the question being whether to wait till October or do it earlier?

One thing the Indian policy makers would be closely watching is the Jackson Hole Symposium as it gets the best monetary minds and is a forum for a common thinking on policy matters. India would hope for more monetary convergence. From a flows perspective, India would be more interested in the combined impact of Fed tapering of its balance sheet and the US bank downgrade by Moody’s. Put together, they have the ability to constrain global liquidity flows.

In India, FPI flows have fallen drastically in the last few weeks and that is not a very exciting narrative for the Indian markets. At a time when inflation is rising, tightening liquidity would be a double whammy, that India would be wary about. The immediate task for the RBI would be how to handle the sudden spike in inflation? That remains the billion dollar question for the RBI.