Weekly Musings – CME Fedwatch change for week to October 27, 2023

30 Oct 2023 , 07:19 AM

CME FEDWATCH CAUTIOUS AHEAD OF FED POLICY 

This was a highly cautious week amidst key data flows on the PCE inflation and GDP front. Both were along expected lines, although the growth engine was spurting at a much stronger pace than expected. However, the big event that the market is preparing is the upcoming Fed meeting and the outcome on November 01, 2023. This is likely to be a critical meeting for a number of reasons. It is clearly that the options for the Fed in terms of more rate hikes are limited and the Fed would want to use it frugally. 

At the same time, the GDP growth, while being positive for the US economy, is also ensuring that inflation does not come down. That explains why the PCE inflation has not been coming down in the last 3 months and has remained static at 3.4%. That is still 140 bps away from the target of 2% and the Fed is already done with its originally committed rate hikes. That is the challenge and that is why the language, tone, and the comments of the Fed chair after the Fed statement assumes a lot of importance. It could be a kind of landmark statement.

NOVEMBER POLICY COULD POSSIBLY MARK A SHIFT BY THE FED

The November 01, 2023 policy statement will not be about mundane things like rate hikes, pause or about bond portfolio reduction. All these have been happening. The Fed rates have been hiked by 525 basis points and the bond book has been cut by $1 trillion. In addition, the banking tightness has also added to the tightening of the economy. Despite all these factors, the consumer spending remains robust and the inflation is still about 140-150 bps away from the eventual target of 2%. How does the Fed address this anomaly? 

That is why, the expectation is that the Fed may announce a policy shift this time around. In fact, the Fed has little choice. It has made its stand clear that it will arrest inflation and keep inflation expectations under check. That is something the Fed cannot go back on. Forcing a large economy like the US to go slow on inflation is not simple as the spillover effects are huge and that is where the Fed will do some juggling and tightrope walking. Will they live with inflation or will the Fed decide that they are ok with higher terminal rates? The answers may be available in the upcoming FOMC meeting in the coming week.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED OCTOBER 20, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to October 20, 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
Nov-23	Nil	Nil	Nil	Nil	Nil	0.1%	99.9%	Nil	Nil
Dec-23	Nil	Nil	Nil	Nil	Nil	0.1%	80.1%	19.8%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	0.1%	71.8%	26.0%	2.0%
Mar-24	Nil	Nil	Nil	Nil	Nil	13.0%	63.6%	21.7%	1.7%
May-24	Nil	Nil	Nil	Nil	5.3%	33.5%	46.6%	13.6%	1.0%
Jun-24	Nil	Nil	Nil	2.6%	19.3%	40.0%	30.2%	7.3%	0.5%
Jul-24	Nil	Nil	1.4%	11.6%	30.5%	34.7%	17.9%	3.7%	0.2%
Sep-24	Nil	0.7%	6.7%	21.4%	32.7%	26.0%	10.5%	1.9%	0.1%
Nov-24	0.3%	3.2%	12.8%	26.1%	29.9%	19.6%	6.9%	1.1%	0.1%
Dec-24	2.1%	8.4%	20.0%	28.2%	24.3%	12.7%	3.8%	0.6%	Nil

Data source: CME Fedwatch

There were several triggers that impacted the CME Fedwatch in the week to October 20, 2023. Here are 3 key factors that had an impact on the CME Fedwatch probabilities.

• The big story in the week to October 20, 2023 was the situation in the Middle East and West Asia and the rising geopolitical risks. It had larger implications for oil prices and fuel inflation. The Israel Hamas war looks like a long drawn war and there were also talks of the US extending sanctions to Iran. If that were to happen, Iran may try to disrupt flows through the Straits of Hormuz. Even if they don’t do it overtly, the apprehensions will spike insurance costs, raising oil prices in the process. That would still be inflationary for the world markets and that has been hitting inflation badly in the US. 

   

• Among the two big speeches during the week to October 20, 2023 were the address by Fed chair Jerome Powell and governor Chris Waller. Both have traditionally veered on the side of hawkishness and this time around it was no exception. Both speeches were careful to underline that high growth combined with tight labour market meant that more rate hikes could not be ruled out. The hint from Powell was of one more rate hike in 2023, although the November policy will have to start looking at the bigger picture.

   

• The week to October 20, 2023 once again saw oil inventories falling sharply as reported by the American Petroleum Institute (API). In the week to October 13, 2023, the oil inventories in the US spiked by 12.94 million barrels, which is a shift away from the trend of the last few weeks. However, that was back to negative in the week to October 20, 2023 as oil inventories fell once again by 4.38 million barrels against market expectations of a fall of just 1.27 million barrels. As long as US inventories remain under pressure, the pressure on oil prices is not going away for sure.

CME FEDWATCH IN THE LATEST WEEK TO OCTOBER 27, 2023

The latest week to October 27, 2023 saw CME Fedwatch stable during the week. In fact, it was too stable, with the probabilities hardly shifting. The consensus now seems to be that the Fed will hold rates at elevated for longer. However, the markets are betting that rates will not be hiked in 2023 and any rate action, if necessary, will only happen in 2024.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Nov-23	Nil	Nil	Nil	Nil	Nil	0.1%	99.9%	Nil	Nil
Dec-23	Nil	Nil	Nil	Nil	Nil	0.1%	80.1%	19.8%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	0.1%	71.8%	26.0%	2.0%
Mar-24	Nil	Nil	Nil	Nil	Nil	13.0%	63.6%	21.7%	1.7%
May-24	Nil	Nil	Nil	Nil	5.1%	32.8%	47.2%	13.9%	1.0%
Jun-24	Nil	Nil	Nil	2.5%	18.6%	39.8%	31.0%	7.6%	0.5%
Jul-24	Nil	Nil	1.6%	13.1%	32.6%	34.0%	15.5%	2.9%	0.2%
Sep-24	Nil	0.9%	8.1%	24.1%	33.4%	23.6%	8.5%	1.4%	0.1%
Nov-24	0.3%	3.6%	14.0%	27.5%	29.7%	18.0%	5.8%	0.9%	Nil
Dec-24	2.3%	9.3%	21.4%	28.7%	23.3%	11.3%	3.1%	0.4%	Nil

Data source: CME Fedwatch

There were 3 major factors influencing the CME Fedwatch in the week to October 27, 2023. Two of them were about actual data flows, but the third was about how the geopolitical situation is shaping up.

• On Thursday, the first advance estimate of Q3 GDP was released by the US Bureau of Economic Analysis (BEA). The quarterly GDP growth stands at 2.1% in Q2 but was expected to spike to 4.1% in Q3, as per Bloomberg estimates. However, the actual growth in GDP in the first advance estimate came in at 4.9%. These were the first estimates and there would be two more estimates. However, the final number is likely to be much better than expectations. That is a strong case of a more cautiously hawkish policy by the Fed. That could have a direct influence on the November Fed policy.

   

• The second big data flow this week was the PCE (private consumption expenditure) inflation on Friday October 27, 2023. The Fed uses the PCE headline inflation and the PCE core inflation as the key triggers for its monetary policy decision making. The headline yoy PCE inflation was flat at 3.4%, exactly as per estimates and even the core PCE inflation came in lower at 3.7%. However, PCE core inflation MOM shows high frequency pressure at 0.4% and that shows the oil price impact. The problem for the Fed is that the PCE inflation has now been static at 3.4% for the last 3 months, still a good 140 bps away from the eventual target of 2% for the Federal Reserve inflation.

   

• There were big speeches from Chris Waller and Jerome Powell during the week and the focus continued to be rather ambivalent. We could see more clarity in the Fed statement on November 01, 2023. However, one critical data point was the personal spending growing 0.7% MOM in September. This is compared to the previous month growth of 0.4% and the current month expectation of 0.5%. Clearly, the enthusiasm over consumer spending appears to be something the Fed had not expected and that is something that will continue to confound the Fed ahead of the November meet.

The Fed has been going relatively steady on bond book unwinding and in the last 15 months only about $1.1 trillion has been unwound. Obviously, the Fed is trying to avoid unnecessary disruptions in liquidity and that is understandable. The Fed is likely to stick to its strategy of holding rates higher for longer and avoid further rate hikes at this point of time. We have to wait and watch for the November 01, 2023 Fed statement to see if the Fed has other plans in mind. It looks like the November policy may be much more than about just another rate hike and mark a bigger shift in the Fed strategy to address the issue of sticky inflation.

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 3 such factors to watch in the coming week to November 03, 2023. 

• The first big event to watch will be the Fed meeting that will commence on October 31, 2023 and conclude on November 01, 2023. The rates are at 5.25% to 5.50% range and it is looking likely as per the CME Fedwatch that the Fed may hold rates at the same level. For now, it does not have any reason to hike rates, although the static PCE inflation 3.4% and the robust GDP growth at 4.9% may be a concern. But the bigger focus will be the Fed statement and the interview of Powell, which we cover in the next point.

   

• Clearly, markets are going to demand some answers from the Fed. The existing policy of hiking rates to control inflation appears to have played out. While inflation is down, it is still 140 bps away from the target of 2%. Normally, it is the last mile that is the toughest and that is the challenge that the Fed is up against. It may call for a change of tack like a sharp crunch in liquidity or indications of much higher terminal rates. Either ways, the markets will expect some indications from the Fed of a new strategic thinking.

   

• The other data point that the markets will watch is the unemployment rate for October, which is again expected at 3.8%, the same as last month. After the brief spike from the lows of 3.3%, the unemployment has also stagnated at 3.8%. This is despite higher participation rate and despite the rates being close to full employment for a very long time now.

On the CME Fedwatch front, the big item to watch out for this week will be the November 01, 2023 policy statement. It could be a big policy statement in terms of a long term shift in strategy. It will certainly be one of the most crucial Fed policy statements in recent months.