Weekly Musings – CME Fedwatch change for week to November 10, 2023

13 Nov 2023 , 06:36 AM

FED STATEMENT TALKS DOVISH, THEN POWELL TALKS HAWKISH

The week before last was all about the Fed policy statement issued late on November 01, 2023. It me be recollected that the Fed had scrupulously maintained status quo on rates and held them in the range of 5.25% to 5.50%. More than the Fed statement, it was the rather liberal and dovish interpretation by the CME Fedwatch that eventually did the trick. It brought down the US 10 year bond yields and also helped the US dollar index to taper. That was the situation at the end of the previous week. Last week things changed sharply. 

The dovish interpretation that the CME Fedwatch had given to the Fed statement in the previous week was largely curtailed by the rather tight and hawkish language of Jerome Powell in his speech at the IMF conference. Speaking at the conference, Powell underlined that the Fed was afar from happy in the way inflation had reacted to the Fed hawkishness. He also added his disappointment at the US inflation still hovering around 150 bps above the 2% inflation target, even after 20 months of sustained hawkishness by the Fed. That urged Powell to indicate that the Fed may be open to rate hikes in the near future and also did not rule out aggressive rate hikes to quickly curb inflation. The impact of the Jerome Powell speech was seen on the US bond yields, the US dollar index and CME Fedwatch.

HOW US BOND YIELDS AND DOLLAR INDEX (DXY) MOVED THIS WEEK

After the sharp fall in the US 10 year bond yields and the sharp fall in the dollar index last week, the current week had started on a cautious note. However, after Jerome Powell made the hawkish intentions quite clear in the speech, the markets saw the bond yields and the dollar index rising. While the bond yields were flat on a week-on-week basis, they continued to be much higher compared to the lows of the week. The reason was the hawkish tone of Jerome Powell’s speech, which resulted in a late rally in the US bond yields. Even the dollar index spiked sharply in the week close to the 106 mark. That is still way off the peak level of over 107 that the dollar index had recently scaled, but clearly, the dollar is getting stronger and the recent speech by Jerome Powell has only helped it along the way. Going ahead, more strength in the US dollar cannot be ruled, on hopes of more rate hikes in future.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED NOVEMBER 03, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to November 03, 2023, before the current week’s 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
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	95.2%	4.8%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	91.2%	8.6%	0.2%
Mar-24	Nil	Nil	Nil	Nil	Nil	25.5%	68.%	6.2%	0.1%
May-24	Nil	Nil	Nil	Nil	14.6%	49.8%	32.8%	2.8%	0.1%
Jun-24	Nil	Nil	Nil	9.4%	37.4%	38.8%	13.4%	1.0%	Nil
Jul-24	Nil	Nil	6.6%	29.1%	38.4%	20.9%	4.7%	0.3%	Nil
Sep-24	Nil	4.6%	22.3%	35.6%	26.2%	9.6%	1.6%	0.%	Nil
Nov-24	2.5%	14.3%	29.5%	30.5%	17.1%	5.2%	0.8%	Nil	Nil
Dec-24	11.9%	24.3%	31.1%	21.7%	9.3%	2.3%	0.3%	Nil	Nil

Data source: CME Fedwatch

Before we get to the triggers in the previous week, let us understand the theme. After a long gap, the previous week saw a sharp spike in dovishness as the CME Fedwatch diverged sharply from the Fed view. While the Fed statement had been broadly hawkish, the CME Fedwatch had interpreted the pause as a dovish signal that the US Fed was done and dusted with rate hikes. The previous week’s CME Fedwatch data needs to be seen in that context. There were several triggers impacting the CME Fedwatch in the week to November 03, 2023 and here were two major drivers. 

• The first big event was the Fed meeting that commenced on October 31, 2023 and culminated with the Fed statement on November 01, 2023. This is where the dichotomy begins. The Fed held rates at the current range of 5.25% to 5.50%, which was broadly along expected lines since the Fed had already spoken about higher for longer. After the Fed statement, it also looked like the Fed would stick to its “Higher for Longer” approach. With PCE inflation tapering to 3.4% and the US GDP growth at a robust 4.9%, the Fed did not see any reason to upset the applecart. This led to a sharp spike in dovishness, which was amply reflected in the CME Fedwatch table above.

   

• The second key data point was the sharp fall in the US 10-year bond yields as well as the sharp fall in the dollar index in the previous week to November 03, 2023. Both were outcomes of the Fed statement, but it was these variables that changed the tone of the CME Fedwatch. The sharp fall actually led the CME Fedwatch to interpret the Fed action as the end of rate hikes.

The previous week to November 03, 2023 had seen CME Fedwatch diverging sharply from the Fed point of view. That was evident in the probabilities shifting clearly on the down side.

CME FEDWATCH IN THE LATEST WEEK TO NOVEMBER 10, 2023

The latest week to November 10, 2023 saw CME Fedwatch get back to its decisive ways. CME Fedwatch has continued to remain hopeful of rapid rate cuts, but it has toned down its optimism a good deal. Now, the expectation is still that rate cuts could be aggressive in 2024 but not as much as envisaged. Also, while the CME Fedwatch in the week to November 03, 2023 had ruled out more rate hikes, the CME Fedwatch for the week ended November 10, 2023 (captured in the table below) is leaving the possibility open for one more rate hike to the range of 5.50% to 5.75%, albeit with low probability levels.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	90.9%	9.1%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	77.7%	21.0%	1.3%
Mar-24	Nil	Nil	Nil	Nil	Nil	12.4%	68.6%	17.8%	1.1%
May-24	Nil	Nil	Nil	Nil	3.8%	29.6%	53.2%	12.7%	0.8%
Jun-24	Nil	Nil	Nil	1.9%	16.6%	41.3%	33.0%	6.8%	0.4%
Jul-24	Nil	Nil	1.0%	9.8%	29.9%	36.9%	18.9%	3.3%	0.2%
Sep-24	Nil	0.5%	5.8%	20.7%	33.7%	27.2%	10.5%	1.6%	0.1%
Nov-24	0.3%	3.0%	12.9%	26.9%	30.5%	19.2%	6.2%	0.9%	Nil
Dec-24	2.2%	9.2%	21.6%	29.2%	23.5%	11.2%	2.9%	0.4%	Nil

Data source: CME Fedwatch

There were several triggers in the latest week, which had an impact on the CME Fedwatch. Here are 2 such factors that influenced the shift in CME Fedwatch in the current week to November 10, 2023. 

• There were several important speeches by Powell, Waller, and Williams. The one speech that influenced the CME Fedwatch in a big way was the Powell speech delivered at the IMF conference in Washington. Speaking at the conference, Powell had underlined that he would have liked to more on controlling inflation. He also suggested that the inflation impact had been disappointing, but also underlined that the Fed would not rest till they brought inflation firmly and decisively to the 2% mark. That actually turned the tide in favour of the CME Fedwatch turning less hawkish. After all, in the past, when there was divergence, it was the CME Fedwatch that had converged towards the Fed view.

   

• The trajectory of the US 10-year bond yields and the dollar index was also a key variable in the current week to November 10, 2023. In the past, the bond yields and the dollar index have been fairly accurate and reliable lead indicators of which way the Fed trajectory is headed. This week, the bond yields bounced and the dollar index also hardened, leading to the CME Fedwatch also turning more hawkish.

On the CME Fedwatch front, the big story this time was about the divergence between the CME Fedwatch and the Fed statement narrowing sharply after the brave divergence of the previous week. Just goes to show, how sentiments take a sharp turn in a matter of just one week.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

There are several triggers for the coming week, which is likely to impact the CME Fedwatch. Here are 2 such factors to watch in the coming week to November 17, 2023. 

• There are important speeches in the coming week, but the markets will focus on the broad macros. For instance, the API crude inventories will be a key determinant of how the oil prices could move and influence fuel inflation in a big way. That is likely to see a bounce after the sharp fall in oil prices last week. 

   

• But, the big event that the CME Fedwatch will be watching would be the consumer inflation story in the US, and this data is expected to be announced on November 14, 2023. The street expectation is that consumer inflation may dip well below 3.5% this month, but Fed would still be concerned about the 150 bps gap. It is still the last mile that is proving tough.

On the CME Fedwatch front, the big story in the coming week would be how the CME Fedwatch compares with the Fed statement. Will the gap widen or would the gap narrow; is the million dollar question for next week.

CME FEDWATCH VS FED STANCE: DICHOTOMY REDUCES SHARPLY IN A WEEK

Dichotomies between the Fed stance and the CME Fedwatch are actually normal. However, in the last few months, there haven’t been instances of such dichotomies as the Fedwatch has broadly mirrored the Fed stance. Last week, the dichotomy had widened sharply, but the latest week again saw this gap narrow. Here is how.

• The Fed, on its part, was emphatic in its statement that it would not hesitate to hike rates further if need be. However, the CME Fedwatch in the previous week had almost ruled out any rate hike. That has changed in the latest week to November 10, 2023, with the Fed once again factoring in a scenario of a possible 25 bps rate hike, but not much beyond that.

   

• The bigger dichotomy is on the rate cut front. The Fed on its part has ruled out any discussion on rate cuts for now. However, the CME Fedwatch, in the previous week, had pegged 5 to 6 rate cuts in the next one year against the Fed suggesting just 2 rate cuts by December 2024. This week, that has normalized with the CME Fedwatch only expecting rate cuts of 3-4 times in the next year.

   

• The third dichotomy is on the assumption of terminal rates on the upside and guidance on the downside. On the upside, the Fed has not given any figure, but had hinted at 6% being the terminal rate on the upside. However, on the downside, the Fed does not see rates going below 5%, by end of 2024. What about the CME Fedwatch? The CME Fedwatch, which had assumed the end of rate hikes last week, has not reconciled to one more rate hike with peak rates at 5.75%. On the downside, the CME Fedwatch does not see rates going below 4.50%-4.75% range. That is a lot less dovish than last week.

The dichotomies have narrowed sharply compared to last week. After all, even in the past, it is the CME Fedwatch that eventually gravitated towards the Fed view. This time around, the CME Fedwatch is just being a lot more pragmatic in its approach.