Weekly Musings – How CME Fedwatch changed for the week to 19th May

22 May 2023 , 09:23 AM

The CME Fedwatch captures the gist of what the market expects from the Fed in terms of rate action. It is a market reality check on the statements made by the Fed governor on the future trajectory of rates. Here we look at the comparison of how the CME Fedwatch looked in the previous week and how it has panned out at the close of the last week on 19^th May. Let us first look at how the CME Fedwatch looked as of the previous week i.e., 12th of May 2023.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550
Jun-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	84.5%	15.5%
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	29.3%	60.5%	10.2%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	17.6%	48.1%	30.3%	4.0%
Nov-23	Nil	Nil	Nil	Nil	Nil	16.1%	45.5%	31.8%	6.2%	0.3%
Dec-23	Nil	Nil	Nil	Nil	15.4%	44.1%	32.4%	7.5%	0.6%	Nil
Jan-24	Nil	Nil	Nil	14.9%	43.3%	32.8%	8.2%	0.8%	Nil	Nil
Mar-24	Nil	Nil	16.1%	42.9%	31.8%	7.9%	0.8%	Nil	Nil	Nil
May-24	4.6%	22.8%	40.1%	25.8%	6.1%	0.6%	Nil	Nil	Nil	Nil
Jun-24	18.8%	33.6%	31.2%	13.5%	2.7%	0.2%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

But, what exactly is the CME Fedwatch. Let us spend a couple of moments on the idea before going to the current CME Fedwatch values.

What does the CME Fedwatch depict?

The CME Fedwatch captures the probabilities of rate hikes and the extent of rate hikes in the forthcoming meetings. These are estimates available for the next on year, which is about 8-10 meetings since the Fed meets once every 45 days to take stock of the monetary situation and evaluate the need for rate hikes. CME Fedwatch looks at these probabilities the other way. It considers the fed futures prices as a legitimate market estimate and then works backward to calculate the implied probabilities of rate hikes. 

Remember, the CME Fedwatch rates are just numbers and hence are not too meaningful in isolation. To get the real value, they must be compared over time. Normally, the CME Fedwatch tends to be volatile around the time of the Fed meeting, Fed statement, Fed minutes, testimony by senior Fed officials etc. In addition, any macro event like bank failures, payment crisis, debt ceiling renewal etc also have an impact on the CME Fedwatch probabilities. We now turn to how the probabilities looked for the latest week ending 19th May 2023.

CME Fedwatch for the week ending 19th May

Let us now look at how the CME Fedwatch looked as of the latest week i.e., 19th of May 2023.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550
Jun-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	82.6%	17.4%
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	80.6%	19.4%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	29.0%	58.4%	12.6%
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	22.5%	51.8%	22.7%	3.1%
Dec-23	Nil	Nil	Nil	Nil	Nil	17.1%	44.7%	29.7%	7.7%	0.8%
Jan-24	Nil	Nil	Nil	Nil	13.8%	39.4%	32.6%	12.0%	2.1%	0.2%
Mar-24	Nil	Nil	Nil	12.1%	36.3%	33.4%	14.5%	3.3%	0.4%	Nil
May-24	Nil	1.7%	15.4%	35.9%	30.8%	12.9%	2.9%	0.3%	Nil	Nil
Jun-24	0.9%	9.3%	26.9%	33.1%	20.8%	7.3%	1.5%	0.2%	Nil	Nil

Data source: CME Fedwatch

Before we make a comparison of the CME Fedwatch for the week ending 19th May with the week ending 12th May, let me admit there are some interesting shifts happening. In the aftermath of the policy statement earlier this month, the Fed was betting heavily on rates falling as much as 100 bps by end of 2023 and by 200 bps by the middle of 2024. This was despite Jerome Powell himself cautioning the markets that they should not expect any rate cuts in 2023, although Powell did not rule out rate cuts in 2024. 

In terms of data points, there are the minutes of the Fed that are expected in the coming week on 26th May 2023. That is likely to provide an insight into the Fed thinking. It is likely to answer questions like whether the Fed is done with rate hikes or there is more to go. It will address whether the Fed would stay hawkish or shift to a more dovish stance. Above all, the dot plot will figure out how the rates would pan out over the next couple of years.

Key takeaways from the weekly comparison of CME Fedwatch

Here is what we gathered from the comparison of the CME Fedwatch on 19th May vis-à-vis on the 12th May 2023.

1. The Fed rates current stand in the range of 5.00% to 5.25%. That means; rates are up a full 500 basis points since the rate hikes began in March 2023. Post the last Fed statement, there was almost a consensus in the market that the Fed was close to the top of the rate cycle, if not at the very top of the rate cycle. Even the Fed admitted that upside risks from here would be limited. That is evident in the comparison, although there is more conservatism in the market about the extent of rate cuts possible in the coming months.

    

2. Just about a week back, the markets were betting on a 100 bps rate cut in 2023 and another 100 bps rate cut in the first half of 2024. That would mean 200 bps rate cut in the next 12 months. However, that kind of dovish optimism appears to have toned down in the latest week. Now, the markets are pegging around 75 bps of rate cut by the end of 2023 and another 75 bps by the middle of 2024. Thus, in just one week, the market expectations of rate cuts over the next one year have come down from 200 bps to 150 bps. Repeated statements to the Fed have led to this shift in sentiments.

    

3. The consensus that has emerged in the last one week is two-fold. Firstly, there is a broad consensus in the market (and that is what even the Fed is indicating) that rate hikes may be completed by the next meeting in June or latest by the July meeting. The markets are factoring in another 25 bps rate hike and that should call the top of the rate cycle. The other area of consensus is that rates will fall over the next one year, but the fall will not be too aggressive. 

    

4. Finally, the broad drivers of the CME Fedwatch in the latest week appear to be factors beyond the inflation rate. Both CPI and wholesale inflation have come down appreciably but it will take some time to reach 2% target. That means, the rates would still remain well above pre-COVID levels for a lengthy period of time. The markets are expecting the banking crisis to tighten credit and act as a proxy for another rate hike. Also, with first estimate of Q1 GDP at just 1.1%, there would be legitimate concerns about the second estimate. That should keep rates in more rational levels.

The next week will be about data flows and the Fed minutes. PCE inflation, GDP second advance estimates and the Fed minutes will hold the key to the CME Fedwatch trajectory in the coming week.