Weekly Musings – CME Fedwatch change for week to September 15, 2023

18 Sep 2023 , 11:40 AM

The big news in the previous week was the US consumer inflation number announced at 3.7%. This is not only 50 bps higher over July but 70 bps higher over the June number. More importantly, this draws the US inflation further away from its target. Now, the rate of inflation is a good 170 bps away from the targeted inflation of 2%. Normally, such a spike in inflation would have resulted in a spike in the rate hike expectations. However, the probability of a rate hike in September continues to be close to zero and the probability of a rate hike in November has also reduced. That means; markets are betting that the Fed may pause in September and the November action would be driven by how inflation pans out in between. There is already pressure from the industry bodies to reduce the hawkishness as it is impacting cost of debt and the investment portfolio valuations. Under these circumstances, the expectation is that the Fed may not be in a hurry to hike rates. Instead, they may allow the rates to hover in a narrow range for a longer time period.

What the CME Fedwatch is indicating is a sharp fall in the probability of rate cuts. The markets are betting that while the rats may hover in a range for longer, there is no real reason for the Fed to cut rates aggressively. About 3 months back, the market bet was that the Fed would cut rates by up to 150 bps from current levels in 2024. However, now that bet is more muted and expects a rate cut of just about 50 bps to 75 bps in the next year. Deep cuts are ruled out as the Fed expects the inflation problem to linger on for much longer. At the same time, the Fed is also having to contend with pressures of a full-fledged recession in the US. While the GDP numbers continue to be broadly robust, there are concerns that much of the growth may be coming from the services sector and the pressures on consumer spending is quite visible. For now, the CME Fedwatch is betting that while inflation may remain sticky due to the energy impact, Fed would be a lot more cautious on hiking rates, as it is already well above the market neutral rates.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED SEPTEMBER 08, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week to September 08, 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	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 previous 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.

• The first signs of ambivalence came from the oil sector. API stocks were expected to fall by 1.43 million barrels but ended up falling 5.62 million barrels. This is a clear indication that oil and energy inflation will continue to exert pressure. However, the higher demand for oil was not backed by growth indicators coming from the BEA.

   

• Another reason for the ambivalence was the diverse view coming in that week from two senior Fed officials viz., Williams and Bowman. Bowman has been known for her penchant for hawkishness and had indicated a 25 bps rate hike with a possible 50 bps rate hike in this year. However, Wiliams added to the market ambivalence by indicating that Fed was not sure if rate hikes were the answer to higher inflation and whether the Fed could really risk a hard landing.

   

• In terms of Fed balance sheet unwinding, the Federal Reserve bond inventory fell from $8.121 trillion to $8.101 trillion. This will avoid too much liquidity tightness caused by rate hikes, but again causes ambivalence as it goes against the logic of tightening. 

For now, the officials of the Fed continue to guide that rates will be headed higher till inflation is under control. As of now, inflation is far from being in control. As Powell said, Too much versus Too little is the debate. It is this ambivalence that the CME Fedwatch during the previous week.

CME FEDWATCH IN THE LATEST WEEK TO SEPTEMBER 15, 2023

The week to September 15, 2023 did not see any distinct shift in the structure of rate hike probabilities. However, the change was more on the reduced probabilities of rate cuts. While the markets are still ambivalent on how much higher the rates will go, one thing that is emerging is the sustained ambivalence. The CME Fedwatch reflects the age old cricketing wisdom, “when in doubt, push out.” The Fed is now expected to keep the rates static in a range for much longer. In fact, the Fed is likely to use a longer pause as an alternative to hiking rates. That would hit two birds with one stone. It will give the right signals and help to manage inflation expectations. At the same time, it will also avoid too much hawkishness.

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	99.0%	1.0%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	73.0%	26.7%	0.3%
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	61.4%	34.1%	4.5%
Jan-24	Nil	Nil	Nil	Nil	Nil	3.2%	60.0%	32.6%	4.2%
Mar-24	Nil	Nil	Nil	Nil	0.7%	15.1%	54.2%	26.6%	3.4%
May-24	Nil	Nil	Nil	0.2%	5.5%	28.2%	45.0%	18.8%	2.2%
Jun-24	Nil	Nil	0.1%	2.8%	16.8%	36.5%	32.0%	10.6%	1.1%
Jul-24	Nil	0.1%	1.6%	10.6%	27.8%	34.0%	20.0%	5.3%	0.5%
Sep-24	Nil	1.1%	7.7%	22.1%	32.0%	24.6%	10.2%	2.1%	0.2%

Data source: CME Fedwatch

The week to September 15, 2023 saw 3 important data points impacting the CME Fedwatch. Here is a quick look at the 3 key triggers for the week just gone by.

• Brent crude prices rallied to above $94/bbl with the US benchmark WTI prices also going above $90/bbl. This is likely to keep the inflation levels higher and make a strong case for rate hikes. Of course, it remains to be seen how the global economics of oil play out and how the Fed reacts to it.

   

• The big news for the week was the announcement of consumer inflation in the US for August 2023. It came in 50 bps higher at 3.7% with most of the pressure coming from energy inflation. The Fed would take some consolation from the fact that food inflation and core inflation were actually 60 bps and 40 bps lower respectively.

   

• In the week to September 15, 2023, there were positive tidings from the industrial growth front. YOY industrial output turned around from negative to positive at 0.25%. The MOM IIP growth at 0.4% was 30 bps above forecasts. This is hardly giving the hint of a slowing economy, but we have to see how the Fed interprets it.

For now, the CME Fedwatch appears to be uncertain on the rates upside but on the downside it is expecting limited cuts by about 50 to 75 bps at the very maximum.

TRIGGERS FOR CME FEDWATCH TO TRACK IN COMING WEEK

There are several triggers for the coming week in the form of Building permits, housing starts, API crude inventories, and the current account data. But the biggest event for the coming week will be the outcome of the FOMC meet on September 20, 2023 and the subsequent Fed statement. Broadly, there are 3 possibilities that we can look at. 

• The Fed may take a decision to front-end the rate hikes in the light of the spike in consumer inflation to 3.7% in August 2023. The Fed may hike the rates by 25 bps in the September meet and possibly hint at a guidance of another 25 bps rate hike before the end of 2023. That would be an extremely hawkish scenario and would most likely have negative repercussions for the global markets.

   

• The second possibility is that the Fed may pause in September, but may give affirmative guidance about a rate hike in November. That would make the rate hike in November almost inevitable and that is what even the Fedwatch appears to be indicating. November, could be the last major rate hike by the US Fed.

   

• The last possibility is that the Fed may continue to maintain a very ambivalent stand and just talk about a possible rate hike in November or December, at the same time giving a guidance that the current spike in inflation was cyclical. This is very likely as it would address the issue of inflation expectations and also of avoiding any growth shocks.

For now, the Fed may leave the markets with an ambivalent view on rates and prefer to take a call with more data supports available. 

FOR INDIA, FED POLICY WILL HAVE LARGER IMPLICATIONS

Each month, the India consumer inflation and the US consumer inflation numbers are announced around the same time. This month, the India inflation came in at 6.83% and the US inflation at 3.7%. Both the India and US inflations have diverged sharply from their targets and the priority for both the central banks would be to put inflation back on track towards its target. The question is what it means for policy outcomes. With the US consumer inflation spiking to 3.7%, they have a problem similar to India. They need to contain inflation but cannot afford to compromise on growth. For India, that problem is a lot stickier since it holds the distinction of being the fastest growing large economy. That is why this September 20, 2023 Fed policy will have deep repercussions for the RBI. The RBI would be very cautious if the Fed was to front-end rate hikes at this juncture.

The RBI will certainly keep a close watch on the shifts in the CME Fedwatch as would Indian financial markets. For India, the 70 bps higher US consumer inflation over the last 2 months does raise some serious policy challenges. For the Fed it has always been inflation first, followed by growth. However, for the RBI, the priorities are slightly different. However, the ground reality is that monetary divergence cannot be sustained for too long by India as it would manifest in the form of shocks in the bond and currency markets. For now, the RBI would just digest the inputs coming from the Fed.