Weekly Musings – CME Fedwatch change for week to September 08, 2023

11 Sep 2023 , 06:39 AM

Even as the US markets had a relatively lighter week in terms of data flows, there were diverse interpretations coming from two senior FOMC members. Firstly, there was John Williams of the New York Fed, who was largely ambivalent about future rate hikes in the US. According to Williams, inflation was still a problem, but it was not too clear if more rate hikes were the answer. Williams almost reiterated what Powell had said at the Jackson Hole symposium about making a choice between too much and too little. The Fed was actually in such a dilemma where the rate hike was not just a simple decision. Growth had held up; labour data was toning down and inflation was gradually moving lower. However, the question was whether the answer to this situation was a rate hike or a pause.

On the other hand, Michelle Bowman of the FOMC was relatively more emphatic about the need for rate hikes. According to Bowman, the real choice before the Fed was between one rate hike of 25 bps and two rate hikes of 25 bps each. Bowman was of the view that tightness had to always be in excess so that the last residues of inflation are wiped out in the process. Bowman underlined that a more rational choice would be two more rate hikes and the Fed must give a guidance accordingly. However, she had left her views about the timing of the Fed rate hikes open. Her contention was that as long as the guidance of the Fed was able to manage and tweak inflation expectations, it was a positive thing. In a sense, the CME Fedwatch represented this classic ambivalence of the FOMC members.

CME FEDWATCH STILL DIVERGES FROM THE FED GUIDANCE

Last week, we had specifically underlined that the divergence between the views of the Fed and the CME Fedwatch had begun to show up again. In the past, the CME Fedwatch had diverged occasionally from the Fed standpoint, but had eventually veered around to the Fed view. The Fed normally takes the communication of its perspective very seriously and rarely allows its actions to diverge from what it says. For the Fed, its credibility lies at the core of such consistent communication. However, the CME Fedwatch, has once again shown the tendency to outguess the Fed on the future trajectory of rates. The Fed has broadly indicated that there would almost be a certain hike of 25 bps with a high probability of 50 bps rate hike. On the other hand, the CME Fedwatch is of the view that rate action is ambivalent even now and it was still uncertain whether there would be more rate hikes or whether the Fed was done with rate hikes for now. 

With Fed rates in the range of 5.25% to 5.50%, it would surely be a tough call for the Fed. They do not have much room to hike rates, yet they need to contain consumer inflation and temper inflation expectations. For the month of July, we have seen CPI inflation and PCE inflation higher by 30 bps over the previous month. Clearly, it was oil that was doing most of the damage due to the spike in global crude prices. However, food and core inflation were headed lower. The ambivalence of the Fed was, in a way, represented by the diverse view of Williams and Bowman during the previous week. While core inflation remains an issue, one big challenge for the Fed is that while goods inflation is being adequately contained, it is services inflation that is actually on a run. The one factor that would determine the Fed direction is the inflation data to be announced next week and that will be the key factor. If inflation edges higher, as is being projected by Reuters, then the Fed may even have to front-end the rate hikes in September itself, instead of waiting till November. It is this absolutely uncertain environment and ambivalence that CME Fedwatch is reflecting.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED SEPTEMBER 01, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to September 01, 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	94.0%	6.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	64.6%	33.5%	1.9%
Dec-23	Nil	Nil	Nil	Nil	Nil	5.6%	61.9%	30.8%	1.7%
Jan-24	Nil	Nil	Nil	Nil	1.1%	17.2%	55.4%	24.8%	1.4%
Mar-24	Nil	Nil	Nil	0.5%	8.2%	34.1%	42.0%	14.5%	0.8%
May-24	Nil	Nil	0.3%	4.6%	21.9%	38.3%	27.4%	7.2%	0.4%
Jun-24	Nil	0.2%	3.1%	15.8%	32.5%	31.2%	14.3%	2.8%	0.1%
Jul-24	0.1%	2.2%	12.0%	27.5%	31.6%	19.4%	6.1%	0.9%	Nil
Sep-24	1.9%	10.1%	24.4%	30.8%	21.8%	8.8%	2.0%	0.2%	Nil

Data source: CME Fedwatch

To recap, here are the 3 factors that had an impact on the CME Fedwatch during the previous week ending September 01, 2023.

• PCE inflation for July 2023 was 30 bps higher over June at 3.3%, while core PCE inflation was 10 bps higher at 4.2%. While crude price inflation was the key driver, the broader trend was that it was services, not goods, that was driving prices. 

   

• A key driver of energy inflation was the pace of fall in crude inventories. API crude inventories fell by 10.6 million barrels; nearly thrice the expected level. This is likely to put further pressure on the Brent crude prices, which had stood at $88/bbl.

   

• The second estimate of Q2-2023 GDP was a bit of a negative surprise. Compared to the first estimate, the second GDP estimate saw 30 bps cut from 2.4% to 2.1%. It does not materially impact the hawkish stance of the Fed, but raises questions about whether the Fed can manage a soft landing, as they have been persistently claiming.

The big change in the previous week to September 08, 2023 was that the CME Fedwatch actually lowered its peak rate assumption from 6.00% to 5.75%. That means the CME Fedwatch is diverging from the Fed stance, but we need to watch how it pans out.

CME FEDWATCH IN THE LATEST WEEK TO SEPTEMBER 08, 2023

The week to September 08, 2023 did not see any distinct shift in the structure of rate hike probabilities. However, one change this week is that it is betting on a much longer ambivalence. This can be partially attributed to the dichotomy in perceptions expressed by two FOMC members; Williams and Bowman The week is also betting that rate cuts may not start before the second quarter of 2024, which in itself is hawkish and expects that the Fed could hold on to rates longer instead of hiking or cutting it. This conflicts with indications that the Fed chair and most Fed members, but that is what makes markets interesting.

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	92.0%	8.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	53.1%	43.6%	3.4%
Dec-23	Nil	Nil	Nil	Nil	Nil	2.0%	52.7%	42.0%	3.3%
Jan-24	Nil	Nil	Nil	Nil	0.3%	10.4%	50.9%	35.6%	2.7%
Mar-24	Nil	Nil	Nil	0.1%	4.0%	25.0%	45.4%	23.8%	1.7%
May-24	Nil	Nil	0.1%	2.8%	18.9%	39.5%	30.0%	8.1%	0.5%
Jun-24	Nil	Nil	0.6%	3.1%	23.1%	37.6%	25.6%	6.6%	0.4%
Jul-24	Nil	0.5%	4.9%	19.5%	34.5%	28.1%	10.6%	1.7%	0.1%
Sep-24	0.4%	3.9%	16.0%	30.9%	29.7%	14.8%	3.9%	0.5%	Nil

Data source: CME Fedwatch

The latest week to September 08, 2023 had 3 important data points which had a bearing on the CME Fedwatch. The broad theme was much longer ambivalence over rate action.

• API stocks are falling faster. This week, API crude stocks were expected to fall by 1.43 million barrels but ended up falling by 5.62 million barrels. This is a clear indication that oil and energy inflation will continue to exert pressure on the price levels.

   

• The big news this week was the contrasting views coming from Williams and Bowman of the FOMC. Bowman, known for her penchant for hawkishness, continued to talk about a certain 25 bps rate hike and a very likely 50 bps rate hike. However, it was Wiliams who made the markets ambivalent by indicating that Fed was not clear if rate hikes were the answer to higher inflation and whether it was worthwhile risking a hard landing.

   

• In terms of the Fed balance sheet unwinding, the Federal Reserve has maintained the pace of $20 billion of bond unwinding per week as this week it fell from $8.121 trillion to $8.101 trillion. This will avoid too much liquidity tightness caused by rate hikes.

While the Fed remains steadfast about controlling inflation at all costs, there is a sense of ambivalence creeping in among the members of the FOMC. As Powell said, Too much versus Too little is the debate. It is this ambivalence that the CME Fedwatch reflected in the week.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

The coming week to September 15, 2023 has 3 important data points which will imp[act the CME Fedwatch. Here is a quick look at the 3 key triggers for the coming week.

• With Brent Crude at $90/bbl and WPI at $87/bbl, the API stocks will hold the key. The fall is expected to tone down. However, the OPEC monthly report will also be out and that will better explain the supply outlook. That will determine whether energy prices continue to remain the key driver of inflation. 

   

• The big news for the week will be the CPI inflation for August. Bloomberg is expecting a 40 bps spike from 3.2% to 3.6%. If that happens with red flags on future trajectory of inflation, then the Fed may be inclined to hike rates in September and then look at one more rate hike by December 2023.

   

• The initial jobless claims are expected to rise in the coming week from 216,000 to 226,000. That could be an indication that the pressure on the labour market is starting to show. It will then be a hard landing versus soft landing choice for the Fed.

For now, the CME Fedwatch is diverging from the stated Fed view. The Fed members are diverging in their views and the CME Fedwatch is factoring in this ambivalence.

FOR INDIA, IT WILL BE A TALE OF TWO INFLATIONS

Each month, the India consumer inflation and the US consumer inflation numbers are announced around the same time. This month, the India inflation will be out on Tuesday and the US inflation on Wednesday. India inflation is already at 7.44% and expected to be above 7% in August. The US consumer inflation, on the other hand, is likely to spike from 3.2% to 3.6%. That is going to create a sense of urgency in the Federal Reserve to hike rates in September policy itself rather than wait till November. The question then is; how will the RBI react. Will it wait till the Fed policy or raise rates ahead of that. If inflation is high, it is very unlikely that the RBI will wait till the October policy for a rate hike decision.

The RBI will certainly keep a close watch on the shifts in the CME Fedwatch as would Indian financial markets. For India, the 30 bps higher US PCE inflation and 30 bps lower GDP reading, poses some sticky questions. RBI may have to quickly take a call on rate hikes. For the Fed it is inflation first, followed by growth. However, for the RBI, the priorities are slightly different. Indian rates cannot diverge for too long as it hits FPI flows. Next week could be a deciding point.