Weekly Musings – CME Fedwatch change for week to August 25, 2023

28 Aug 2023 , 07:28 AM

It is once a year towards the end of August, that the most powerful economic policy makers from around world rub shoulders with academicians, economists and journalists at Jackson Hole, Wyoming. Over the last 40 years, Jackson Hole has become the veritable boiling point of macroeconomic ideas, especially with respect to central banking policies. Normally, the chiefs of the most powerful central banks in the world like the head of the US Fed, the chief of ECB as well as the chiefs of the Bank of England and the Bank of Japan are present. Jackson Hole offers an informal setting for central banks to set the tone for global monetary policy and ensure that monetary divergence is reduced to the extent possible.

This week at Jackson Hole, the focus was entirely on Jerome Powell, the Fed chair. His speech at the Jackson Symposium focused on the fact that inflation was sticky for longer than anticipated. Powell also added that the Fed was not done with rate hikes and they would be open to hiking rates further if inflation levels so warranted. Currently, the inflation is at 3.2% and the Fed target is to bring inflation to 2%. However, the most interest part of his speck at Jackson Hole was the debate on “doing too much versus doing too little.” Powell was almost assuring the markets that, while price stability would be the primary goal, the Fed will ensure that the growth momentum does not get dissipated. 

CME FEDWATCH HINTS AT PAUSE IN SEPTEMBER, HIKE IN NOVEMBER

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. However, in the last two weeks, that narrative appears to have changed. The focus is not on long pause, but on front-ending rate hikes to get done with the hawkishness. Then, the Fed will allow a long period for the impact of the hawkishness to play out on the interest rates. In the previous week, Neil Kashkari of the FOMC had hinted that more rate hikes were imminent. At Jackson Hole, Powell underlined that 1 or 2 more rate hikes were on the cards, if inflation continued to show resistance. 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. 

However, the recent minutes of the FOMC and even the speech by Jerome Powell at Jackson Hole have made two things clear. There was no sanctity to peak rates and that would depend on the inflation trajectory. Expectations that 6% may be the peak rate, may just about be approximately right. Secondly, rate cuts are ruled out in the first quarter of 2024, although they do look likely in the second quarter of calendar 2024.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED AUGUST 18, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to August 18, 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	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 impacted the CME Fedwatch during the week to August 18, 2023.

• FOMC minutes announced during the previous week were quite emphatic that more needed to be done to rein in inflation. After 525 bps of rate hikes, consumer inflation was still 120 bps away from its 2% target. Virtually, the CME Fedwatch is now ruling out any relaxation on inflation control and has also given up on the idea of long pause.

   

• Neil Kashkari, one of the members of the FOMC, admitted it was tough to call the top on rates. The only target was to rein in inflation to 2%, whatever it entailed. That means, logically, the rate hikes could even extend into 2024, delaying rate cuts further.

   

• While food inflation has been  under control in the US and food inflation is tapering, there are apparent worries about fuel inflation. Brent crude has jumped to $85/bbl and the high base effect is waning. Fuel inflation could get stickier for the US Fed.

In the previous week to August 18, 2023, the CME Fedwatch gave the first indications that rates could go even beyond 6%. The debate, now, is no longer about the long pause. 

HOW CME FEDWATCH SHIFTED IN THE WEEK TO AUGUST 25, 2023

The week to August 25, 2023 saw a distinct shift in the probabilities to the right. The probability of rates now going up to 6% has increased sharply, the rate cuts are now likely to start by mid-2024 and the rate cuts are not likely to be anything aggressive. In a nutshell, even post the rate cuts, the Fed rates would be well above the pre-pandemic levels.

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	80.0%	20.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	44.5%	46.7%	8.9%
Dec-23	Nil	Nil	Nil	Nil	Nil	1.8%	44.5%	45.2%	8.5%
Jan-24	Nil	Nil	Nil	Nil	0.3%	8.0%	44.6%	39.9%	7.3%
Mar-24	Nil	Nil	Nil	0.1%	2.6%	19%	43.2%	30.1%	5.1%
May-24	Nil	Nil	Nil	1.2%	10.1%	30.1%	37.2%	18.7%	2.8%
Jun-24	Nil	0.3%	0.7%	6.0%	20.3%	33.9%	27.2%	10.1%	1.3%
Jul-24	Nil	0.5%	4.3%	16.1%	29.8%	29.3%	15.5%	4.1%	0.4%
Sep-24	0.4%	3.5%	13.5%	26.8%	29.4%	18.6%	6.6%	1.2%	0.1%

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 25, 2023.

• Firstly, there was the Michelle Bowman speech during the week. Bowman is a known hawk and she reiterated the possibility of two more rate hikes of 25 bps as a very likely scenario. In fact, towards the end of the week, that is what even the CME Fedwatch is starting to indicate.

   

• The Fed has been cutting its bond book aggressively. While the reduction was marginal in this week, the overall unwinding of the bond book has been to the tune of $1 trillion since May 2022. That is also contributing to the tightness in the market and may reduce the need for aggressive rate  hikes.

   

• But the big news was the speech delivered by Jerome Powell at Jackson Hole. While Powell underlined the need to remain hawkish till inflation was reined in, the markets focused on the “doing too much versus doing too little” statement of Powell. That hinted that, at some point, the focus of the Fed may gravitate back towards growth, even as it remains committed to inflation for now.

When it comes to CME Fedwatch, the week to August 25, 2023 saw the markets factoring in rates going all the way up to 6% during 2023. The rate cuts are also likely to be back-ended with the eventual rate cuts lower than expected.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

The coming week to September 01, 2023 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. API stocks fell by 2.42 million barrels in the latest week and that is indicative of continued pressure on oil prices. Falling US inventories would mean brent getting closer to $90/bbl and that could revive fuel inflation all over again. That is likely to heighten the hawkish stance of the Fed.

    

2. The all-important GDP data (second estimate) for the June quarter will be out this week. The first advance estimate had pegged growth at 2% and that is likely to improve in the second and third readings. Also, Q3 GDP growth is likely to veer towards the 8% mark, as per the Atlanta Fed. If the GDP still stays robust, it would only embolden the Fed to get more aggressive on its anti-inflation program.

    

3. Finally, there is the critical PCE inflation for July that will be announced this week. Unlike consumer inflation, the PCE inflation is based on consumption spending and is a good gauge of prices and of consumer sentiments. Last month, PCE inflation had dropped to 4% and the markets would be focused on the headline PCE inflation as well as the core PCE inflation. If either of them spikes, the Fed will have reasons to be more hawkish.

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. However, for now, the Fed is not relenting on its hawkish stance.

WHAT INDIA WILL FOCUS ON THIS WEEK?

Indian markets, and especially the RBI, would keep a close watch on the shifts in the CME Fedwatch. After all, it is a market driven indicator and it gives the perfect market reflection of which way the monetary winds are blowing. For India, the 20 bps higher US inflation came as a temporary relief. However, with Indian consumer inflation coming in at 7.44% for July 2023, there is not much that India can really celebrate 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? For now, the RBI is non-committal, but that is a question that must be playing.

What would Indian policy makers take away from the Jerome Powell speech at the Jackson Hole Symposium? For now, it looks like the Fed would first focus on getting inflation under control and then worry about GDP and consumer spending. To the advantage of the Fed, neither GDP nor consumer spending appears to have been negatively impacted by the spike in rates. After all, when inflation expectations are being managed, that is not much more than people can generally ask for. India will surely hope for more monetary convergence as it reduces the risks of financial market volatility. However, that does not appear to be on the agenda for now as most central banks, for now, would prefer to adopt an insular approach.

In India, FPI flows have fallen drastically in the last few weeks and that is not a very exciting narrative to write about. At a time when inflation is rising, tightening liquidity would be a double whammy, that India would be wary about. But, for now, the RBI focus will be on consumer inflation. If that can be controlled; that is half the monetary battle won!