Weekly Musings – CME Fedwatch change for week to November 17, 2023

20 Nov 2023 , 07:01 AM

US INFLATION MAKES CME FEDWATCH DOVISH ALL OVER AGAIN

The last two weeks was all about the status quo in the Fed policy statement and the subsequent hawkish speech given by Jerome Powell as the IMF conference. This week, there were no direct reference to the rate action, but the markets came to its own conclusion post the consumer inflation data in the US for October 2023. Here is a small caveat. The Fed does not use the US consumer inflation but instead relies on the PCE inflation for its rate decisions. The PCE inflation looks at inflation from a private consumption expenditure (PCE) perspective and is considered to be more representative. However, in reality, the consumer inflation and the PCE inflation tend to move in tandem. Hence, while they differ in content, they are broadly reflective of a similar underlying trend in prices.

Consumer inflation for the month of October 2023 came in sharply lower at 3.2% compared to 3.7% in the previous two months. Post the inflation number, there is once again a very sharp divergence between the views of the Fed and the views of the CME Fedwatch. While the US Fed (including chairperson Jerome Powell) hold to their “higher for longer” approach, the CME Fedwatch has interpreted it as a signal that rate hikes were done and dusted. IN fact, the CME Fedwatch has also gone ahead and factored in very aggressive rate cuts in 2024, although the Fed has not hinted at more than 2 rate cut cuts by end of 2024. We have to wait and watch, what is the actual picture that emerges between these two extremes.

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

The US 10 year bond yields and the dollar index have been on a virtual see-saw in the previous two weeks and that trend has continued in the latest week to November 17, 2023 also. This week, there was no Fed statement and no Jerome Powell speech, but it was all about the inflation data. Post the US inflation coming 50 bps lower at 3.2%, the US bond yields fell sharply from 4.638% to 4.439% during the latest week. At the same time, the dollar index (DXY) also fell sharply during the week from 105.63 levels to 103.82 levels. Both these variables, however, had a strong influence on the CME Fedwatch as it is almost showing a high level of confidence that rate hikes by the Fed were done for now. Also, the CME Fedwatch is indicating a series of rate cuts in 2024 and that has been a direct outcome of the sharp fall in the US bond yield and the US dollar index. It looks like the markets are buying into this “end of rate hike” argument.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED NOVEMBER 10, 2023

The previous week to November 10, 2023 saw CME Fedwatch converge a lot more towards the Fed point of view. CME Fedwatch continued to remain hopeful of rapid rate cuts, but it had toned down its optimism in the previous week to November 10, 2023. Now, the expectation is still that rate cuts could be aggressive in 2024 but not as much as envisaged. CME Fedwatch in the week to November 03, 2023 had ruled out rate hikes completely by the US Fed. However, 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. However, the bias is more towards rates on the downside.

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 week to November 10, 2023, which had an impact on the CME Fedwatch. Here are 2 factors that influenced the shift in CME Fedwatch in the week to November 10, 2023. 

• The week to November 10, 2023 had several key speeches made by Powell, Waller, and Williams. The one speech that influenced the CME Fedwatch in a meaningful way was the speech delivered by Fed chair Jerome Powell at the IMF conference in Washington. Speaking at the conference, Powell made it rather explicit that he would have liked to do more on controlling inflation. Powell had gone to the extent of suggesting that inflation impact had been disappointing, but also underscored that Fed would not rest till they brought inflation firmly and decisively towards the 2% mark. That speech had turned the tide in favour of the CME Fedwatch turning less dovish and converging with the Fed point of view. It looked like old days when the CME Fedwatch would converge towards the Fed point of view.

   

• The trajectory of the US 10-year bond yields and the dollar index was also a key variable in the week to November 10, 2023. The speech of Jerome Powell had a profound impact on the US bond yields and the US dollar index. Both these linked variables bounced back sharply in the week to November 10, 2023; showing that the CME Fedwatch was once again willing to converge towards the Fed worldview. 

The week to November 10, 2023 saw the CME Fedwatch gradually converging towards the Fed view on rates. In that week, the speech by Jerome Powell had made the difference. After all, the Fed not only had to manage inflation but also inflation expectations. It is, then, only obvious that the Fed takes its communication very seriously.

CME FEDWATCH IN THE LATEST WEEK TO NOVEMBER 17, 2023

The latest week to November 17, 2023 saw CME Fedwatch seesaw continue as it once again diverged from the Fed point of view. This time, the CME Fedwatch appears intent on charting its own path and the US bond yields and the US dollar index have also broadly supported the CME Fedwatch point of view. What is the broad takeaway from the latest week. CME Fedwatch has almost ruled out any further rate hikes from the current level as can be seen in the probability table below. However, by the end of 2024, the CME Fedwatch is assigning a high probability that the Fed rates could fall as much as 125 bps from current levels of 5.25% to 5.50%.

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	100.0%	Nil	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	100.0%	Nil	Nil
Mar-24	Nil	Nil	Nil	Nil	Nil	28.0%	72.0%	Nil	Nil
May-24	Nil	Nil	Nil	Nil	12.6%	47.8%	39.5%	Nil	Nil
Jun-24	Nil	Nil	Nil	7.0%	32.0%	43.3%	17.7%	Nil	Nil
Jul-24	Nil	Nil	3.9%	20.9%	38.3%	29.0%	7.8%	Nil	Nil
Sep-24	Nil	2.4%	14.5%	31.7%	32.5%	15.9%	3.0%	Nil	Nil
Nov-24	1.3%	8.8%	23.6%	32.1%	23.8%	9.1%	1.4%	Nil	Nil
Dec-24	7.4%	19.0%	29.5%	26.3%	13.6%	3.8%	0.4%	Nil	Nil

Data source: CME Fedwatch

There were several triggers for the week, that had a direct impact on the CME Fedwatch. Here are 2 such factors that influenced the CME Fedwatch in the week to November 17, 2023. 

• To begin with, there speeches by Bowman and Barr, and both the speeches broadly aligned with the Fed perspective given by Jerome Powell. However, a sharp spike in the API crude inventories in the US had led to a sharp fall in the global oil prices and reduced the risk of energy inflation. That was a trigger that inflation could stay lower and influenced the CME Fedwatch to be more dovish in its approach, compared to Fed.

   

• The big data point for the CME Fedwatch during the week to November 17, 2023 was the October consumer inflation. The US consumer inflation for October fell by 50 bps to 3.2% from 3.7% in the previous two months. This is sharply lower than the 3.5% that the markets were expecting. Of course, the Fed remains concerned about the 120 bps gap compared to the eventual 2% inflation target. It is still the last mile that is proving tough; but the CME Fedwatch looks convinced that the focus will now be on capping rates.

The latest week to November 17, 2023 again saw the Nifty 

TRIGGERS FOR CME FEDWATCH TO TRACK IN WEEK TO NOVEMBER 24, 2023

There are several triggers for the coming week, likely to impact CME Fedwatch. Here are 2 such factors to watch in the coming week to November 24, 2023. 

• The big data point in the US, which will influence the CME Fedwatch in the week to November 24, 2023 will be the announcement of the FOMC minutes. As is the practice, the Fed will announce the minutes after a gap fo21 days on November 22, 2023. While the Fed decision is known, the markets will be interested in the specific viewpoints of the FOMC members and the dot plot chart of rate expectations. That will be the key.

   

• Another important data-point this week will be the preliminary release of the Atlanta Fed GDP-Now, which is the fourth quarter GDP estimate. It is estimated to be at 2%, although Q3 is expected to be well above 4.5% based on the first advance estimate of Q3 at 4.9%. this will be the key to future rates trajectory of the Fed.

On the CME Fedwatch front, the big story in the coming week would be how the Fed minutes pan out. Will the gap widen or would the gap narrow between the CME Fedwatch and the Fed view; remains the million dollar question.

CME FEDWATCH VS FED STANCE: DICHOTOMY IS BACK, ALL OVER AGAIN

Dichotomies between the Fed stance and the CME Fedwatch are nothing new. In the last 3 weeks, there has been a see-saw. After, the Fed policy statement, the divergence was stark, but had narrowed after Powell warned about more rate hikes in his speech in the next week. In the latest week to November 17, 2023, the divergence has widened. Here is how.

• The Fed has stayed emphatic in its view that it would not hesitate to hike rates further if the situation warranted. However, the CME Fedwatch in the previous week had converged with the Fed. However, in the week to November 17, 2023, the divergence is back and it is only a lot starker this time around. Fed has given a guidance of 1 to 2 rate hikes, but the CME Fedwatch has already declared an end to the rate hike cycle.

   

• The bigger dichotomy is on rate cuts. The Fed has ruled out discussion on rate cuts for now. However, CME Fedwatch, has pegged 5 to 6 rate cuts in the next one year against the Fed suggesting just 2 rate cuts by December 2024. The latest CME Fedwatch is betting rates falling to as low as the range of 400-425 bps by end of 2024. 

   

• 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 hinted at 6% being the terminal rate. However, on the downside, the Fed sees 5% by the end of 2024 as a best case scenario. On the other hand, the CME Fedwatch has now almost declared the end of rate hikes with zero probabilities assigned to rate hikes from here. Peak rates have been scaled, according to CME Fedwatch, but rate cuts could go as low as 4.00-4.25%. 

The dichotomies have widened decisively in this week, compared to last week. In the past, it is the CME Fedwatch that eventually gravitated towards the Fed view. As we have seen, a lot changes in a week, so we have to take it one week at a time.