Weekly Musings – How CME Fedwatch changed for the week to July 14, 2023

17 Jul 2023 , 06:45 AM

These factors were; the ECB/BOE hawkish stance, Governor Waller speech and the all-important consumer inflation data in the US for June 2023. Obviously, the last of the above three items had the deepest impact on the Fedwatch due to its pivotal role in US monetary policy. It may be recollected that consumer inflation fell to 3% in the month of June 2023, a fall of 190 basis points in the last 2 months. But, we will come back to that later.

Let now turn to the CME Fedwatch. It calculates the probabilities of rate hikes across different FOMC meetings based on actual Fed Futures traded prices and hence has a market perspective to it. This is real time and keeps changing on a continuous basis and hence must be tracked on real time. However, when you look at the CME Fedwatch on a week on week basis, it 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, but the tone of the Fed remained hawkish. Now, with the latest inflation data coming out at multi-year lows, there has been a distinct shift in the CME Fedwatch and although it has not yet diverged from the official stance. But first, a recap of the previous week to set the tone.

Recap – CME  Fedwatch for the week ended June 07, 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	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

The week prior to the latest week had key data points like the FOMC minutes, unemployment level and the merchandise trade. Le us take a quick peak at the FOMC minutes. The minutes had 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. The implication is that; Fed would not be too keen to shift the status quo unless there were some real inflation concerns. However, the other two triggers were pro-growth. The unemployment level at 3.6% for June was lower compared to 3.7% in May 2023. This was an indication that the impact on growth was likely to be limited and also the probability of recession had sharply reduced. The trade data for May 2023 saw a sharp narrowing of the merchandise trade deficit and widening of the services surplus. This had, once again, given a pro-growth twist to the market thinking.

What we read from the CME Fedwatch in the week to July 14, 2023

After a long time, the hawkish undertone of the CME Fedwatch turned into a relatively dovish tone and that was all thanks to the sharply lower inflation in the month of June 2023. Let us now look at how the CME Fedwatch evolved during the latest week i.e., the period ending July 14, 2023. The underlying story may still hint at rate hikes, but the shift in probabilities towards the dovish left is almost palpable in the latest week.

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	7.0%	93.0%	Nil	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	6.2%	82.7%	11.2%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	2.5%	37.8%	53.1%	6.5%
Dec-23	Nil	Nil	Nil	Nil	1.9%	28.2%	49.0%	19.2%	1.8%
Jan-24	Nil	Nil	Nil	1.0%	16.6%	39.8%	32.3%	9.5%	0.8%
Mar-24	Nil	Nil	0.4%	6.6%	24.9%	37.1%	24.1%	6.3%	0.5%
May-24	Nil	1.0%	8.4%	26.1%	35.8%	22.4%	5.8%	0.5%	Nil
Jun-24	0.6%	5.1%	18.2%	31.5%	28.4%	13.2%	2.8%	0.2%	Nil
Jul-24	5.0%	16.5%	29.7%	18.8%	15.2%	4.2%	0.5%	Nil	Nil

Data source: CME Fedwatch

Let us now turn to the 3 factors that influenced the CME Fedwatch probabilities in the latest week. Of course, the biggest factor influencing this dovish shift was the inflation data. For the month of June 2023, the headline consumer inflation came in sharply lower at 3%. Now, consumer inflation has fallen by 190 basis points in just 2 months and that is expected to induce the Fed to rethink on its current hawkish stance. It is likely that the FOMC would get increasingly divided on the trajectory and that is reflected in the CME Fedwatch. The second factor is still hawkish as Government Waller, in his recent speech, has still hinted at 2 more rate hikes of 25 bps each in the current fiscal year. Lastly, ECB rates are at 22 year highs and BOE rates are at 15 year highs and they are still hawkish. That will also be an overhang.

How exactly did the CME Fedwatch probabilities shift during the week to July 14, 2023. The underlying story has changed sharply, although the Fed and the markets still appear to agree on two more rate hikes. However, the probability of a third rate hike appears to have fully diminished in the current week. Also, in the previous weeks, the CME Fedwatch was hinting at a maximum rate cut of 100 basis points in 2024 after 50 bps rate hike in the current year. That would have been a net impact of just about 50 bps from current levels. Now the CME Fedwatch is factoring in 2 rate hikes of 50 bps in the current year, but the rate cuts are expected to be front-ended in 2024. Also, the CME Fedwatch is now pencilling in rate cuts of up to 150 basis points after a 50 bps rate hike, which would be a net reduction of 100 bps from the current levels. Probabilities have also sharply shifted to the dovish left.

Triggers for CME Fedwatch to track in the coming week

Towards the end of this month, the Fedwatch will closely track the PCE inflation data (which is the benchmark used by the Fed) and the first estimate of Q2 GDP. Both will have an important bearing on the Fed stance. Above all, there is the critical FOMC meet coming up on July 26, 2023. But for the coming week, some of the macro triggers will still be watched. 

1. The core retail sales and the headline retail sales data for June will be put out in July 18, 2023. The focus of this data will be to understand if the persistent hawkishness has hit retail consumer demand. In the past, the impact has been limited and the Fed would be OK if there is not too much of crimping of consumer demand at the retail end.

    

2. The other important growth indicator, the index of industrial production (IIP) will also be announced on July 18, 2023. In the previous month, MOM IIP was negative and that is expected to continue in this month also. In addition, the yoy IIP was 0.23% in May and that trend will be crucial as the Fed would be OK with flat to improved IIP. Retail sales and IIP will be key to understand the chances of a hard landing of the US economy.

    

3. Lastly, oil prices will hold the key to inflation since lower energy prices yoy has been one of the biggest drivers of lower inflation. The API crude stocks have been hinting at a sharp fall in US oil inventories and the Fed would be tracking the Brent Crude prices to see if the prices really go substantially above the $80/bbl mark.

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. For now, the Fed is quite emphatic about two more rate hikes of 25 bps each in this year. Above all, India would be closely watching the July 26, 2023 policy of the US Fed as the RBI would be happy if the Fed maintains a pause for one more month. It does away with the risk of divergence.

India has two additional challenges in the current month. Firstly, even as US inflation in June fell from 4% to 3%, India consumer inflation bounced from 4.25% to 4.81%. As a result, the gap advantage has vanished. In May, RBI was just 25 bps short of its inflation target while the Fed was 200 bps short of its inflation target. As of June, both are between 80 bps and 100 bps away from their respective targets. Secondly, India has a concern on food inflation. The food inflation was first spurred by fears of deficient rainfall and has later been triggered by excess rainfall damaging crops. Unfortunately, there is little policy control that can be exercised on either. For now, India would be hoping against hope for a benign CME Fedwatch and a pause in the July 26, 2023 Fed policy.