Weekly Musings – How CME Fedwatch changed for the week to July 07, 2023

8 Jul 2023 , 12:58 PM

These factors were; FOMC minutes, unemployment data and the US trade data. Now, it is well known that the CME Fedwatch captures the probabilities of rate hikes over the next 10-12 FOMC meetings. These are probabilities that are derived backward from the Fed Futures trading. The futures price is assumed to be a reasonable reflection of the value of the trade.

Based on the prices the probabilities of rate hikes across different FOMC meetings are calculated. This is real time and keeps changing on a continuous basis and hence must be tracked on real time. However, week on week gives a good idea of the shift. It may be recollected that between March 2022 and May 2023, Fed rates were increased by 500 basis points from the range of 0.00%-0.25% to 5.00%-5.25%. However, the Fed had then paused in the June meeting. However, the tone of the Fed has still be hawkish, although the members of the FOMC are now more divided over the timing of the rate hikes and the need to further front-end rate hikes from here on.

Recap – CME  Fedwatch for the week ended June 30, 2023

Here is a quick recap of how the CME Fedwatch looked like for the previous week, before the above data points on the Fed meet and inflation were factored in.

Fed Meet	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	13.2%	86.8%	Nil	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	10.0%	69.1%	20.8%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	7.5%	54.0%	33.2%	5.3%
Dec-23	Nil	Nil	Nil	Nil	Nil	0.9%	13.2%	51.4%	29.7%	4.7%
Jan-24	Nil	Nil	Nil	Nil	0.3%	5.5%	27.4%	43.4%	20.4%	2.9%
Mar-24	Nil	Nil	Nil	0.2%	2.9%	16.5%	35.4%	31.9%	11.7%	1.5%
May-24	Nil	Nil	0.1%	2.5%	14.3%	32.3%	32.5%	15.0%	3.1%	0.2%
Jun-24	Nil	0.1%	1.2%	7.9%	22.5%	32.4%	24.5%	9.6%	1.8%	0.1%
Jul-24	0.1%	1.0%	6.4%	19.4%	30.3%	26.2%	12.8%	3.5%	0.5%	Nil

Data source: CME Fedwatch

The week prior to the latest week had key data points like the Fed chair speak and the GDP data for Q1 in the US. The Powell speech once again underlined that the Fed had not yet given up on its hawkish stance. It was still pencilling about 2 to 3 more rate hikes of 25 basis points each in a worst case scenario. It was already clear that the Fed will go all out to fight inflation to the finish. After all, it was not just about price stability but also about anchoring inflation expectations in the US and around the world. However, the first indications against the recession fears had come in the week in the form of the labour data with the unemployment rate for June 2023 falling from 3.7% to 3.6%. This gave the first indication that the impact on growth may be limited and recession fears may be unwarranted.

What we read from the CME Fedwatch in the week to July 07, 2023

Let us now look at how the CME Fedwatch evolved during the latest week i.e., the period ending July 07, 2023. The underlying story is the same; it is just that the hawkish undertone has been underlined and also accepted by the market.

Fed Meet	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575	575-600
Jul-23	Nil	Nil	Nil	Nil	Nil	5.1%	94.9%	Nil	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	3.9%	73.3%	22.8%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	2.8%	54.5%	36.5%	6.2%
Dec-23	Nil	Nil	Nil	Nil	0.7%	12.1%	51.4%	30.8%	5.0%
Jan-24	Nil	Nil	Nil	0.2%	3.6%	22.9%	46.2%	23.9%	3.6%
Mar-24	Nil	Nil	0.1%	1.6%	11.7%	32.6%	36.7%	15.2%	2.1%
May-24	Nil	Nil	1.2%	10.0%	30.1%	36.7%	18.0%	3.7%	0.3%
Jun-24	Nil	0.7%	5.8%	19.7%	32.7%	27.5%	11.3%	2.1%	0.1%
Jul-24	0.5%	4.3%	16.1%	29.8%	29.1%	15.3%	4.3%	0.6%	Nil

Data source: CME Fedwatch

Let us now turn to the 3 factors that influenced the CME Fedwatch probabilities in the latest week. Firstly, the FOMC minutes during the week underlined that the Fed would stay hawkish, but it also indicated that, going ahead, the rate hikes would be more calibrated and data driven. While the FOMC members indicated at 2-3 rate hikes in the future, there were no commitment on time lines. That means; the Fed would not be too keen to shift the status quo unless there were some real inflation concerns. Secondly, the unemployment level at 3.6% for June was lower compared to 3.7% in May 2023. This hints that the growth impact was likely to be limited. In short, the recession may be largely unfounded. Lastly, the trade data for May 2023 saw narrowing merchandise trade deficit and a wider services surplus, both positive signals of US economic growth. These helped CME Fedwatch stabilize.

How did the CME Fedwatch probabilities shift during the week to July 07, 2023. The underlying story is broadly the same. However, some of the probabilities with a hawkish bias got reinforced during the week. For instance, the probability of stable to higher rate increased while the probability of rate cuts (even in 2024) sobered. The latest probabilities indicate that 25 bps rate hike in July is now almost inevitable. What we also see is that the probability of a 50 bps rate hike and of a 75 bps rate hike have gone up sharply in the latest week, which is in sync with the FOMC view point. The bias is clearly hawkish and it appears to be a case of the markets buying the Fed talk and changing expectations according to the language of the Fed. For now, rate cuts are ruled out in 2023 and even in 2024, the rate cuts do not look likely to go below the range of 4.50% to 4.75%. Of course, that is still well above the long period median.

Triggers for CME Fedwatch to track in the coming week

The next week will be a busy week for the CME Fedwatch as there are a number of data points to watch out for. Here is a quick rundown on the key factors that will have an impact on the CME Fedwatch probabilities on future rates trajectory.

1. There are about 4 FOMC members who are likely to speak in the coming week. While Powell has set the tone in his presentation to the Congress, the views of other FOMC members are the key to understanding how the consensus is likely to shape up. Already, there is a widening gap within the FOMC between those concerned about inflation and others concerned about growth. These dichotomies will now become evident in the Member speak in the coming week.

    

2. On July 12, 2023, the US consumer headline inflation and the consumer core inflation will be announced by the Bureau of Labour Statistics (BLS). While the overall inflation has progressed lower, core inflation still remains elevated at around 4.6%. Apart from the yoy inflation, the markets will also focus on the MOM inflation and that is likely to be higher in June as per Bloomberg estimates. That will be another key data point for determining the direction of the CME Fedwatch probabilities.

    

3. Of course, the Fed will also keep an eye on what other central banks are doing on the monetary management front. For now, there clearly seems to be a dichotomy with the central banks of Japan, China and India still going easy on monetary tightening while the US, EU, and UK till are in the hawkish zone. The pause in June 2023 by the US Fed is a signal that there is a serious rethink going on.

From India’s perspective, there will be a close watch on the shifts in the CME Fedwatch as it gives the best picture of which way the monetary policy winds are blowing. If you go by the communication of the Fed till date, they have been very emphatic that rate hikes are not done yet, although front-ending is done for now. It needs to be seen what policy form does the subdued hawkishness of the Fed assumes in the coming weeks.

India has an advantage that inflation is just about 25 bps short of its 4% target while in the US the target is still 100 bps away. However, if you read the minutes of the RBI MPC, even the three RBI members have not committed to getting done with rate hikes. They are keeping the window open, should the inflation get impacted by the delayed Kharif sowing and the resultant food price inflation, that looks likely. India has reached a stage where inflation is close to the RBI target, although core inflation is still very high. How US monetary policy pans out in the next few months, and what the CME Fedwatch indicates will surely have a bearing on RBI policy stance.