Weekly Musings – How CME Fedwatch changed for the week to June 16, 2023

19 Jun 2023 , 07:29 AM

That is not surprising considering there were two major events in the previous week. Firstly, there was the US consumer inflation number which came down sharply by 90 basis points from 4.90% in April 2023 to 4.00% in May 2023. The 90 bps fall in consumer inflation was led by a sharp fall in food inflation and energy inflation even as core inflation tapered by just about 20 points from 5.50% to 5.30%. 

That is something the Fed will continue to look askance at. The second major event was the Fed policy statement during the week, which kept rates static at the range of 5.00% to 5.25%. This is the first time in 15 months that the Fed has not hiked rates. Over the last 10 meetings in succession, the Fed had  hiked rates each time, taking the Fed interest rates from the range of 0.00%-0.25% to 5.00%-5.25%. Let us first look at what impacted the Fedwatch probabilities in the week.

What impacted CME Fedwatch probabilities in the week to 16-Jun 2023?

Broadly there are three trends emerging in the current week. The view of the Fed has not changed much and the pause in rates in June must just be seen as the Fed buying time. At least, that is what Powell has taken pains to underline in his post-policy speech. Inflation has come down to 4% but it is still far away from the Fed target of 2% inflation. An important point made by Powell in his speech was the guidance on terminal rates. Powell has stated that in a worst case scenario, there would be two more rate hikes of 25 bps each, which means the peak Fed rates could be in the range of 5.50% to 5.75%. 

However, while that is likely, it does not look very probable if one goes by the CME Fedwatch. Lastly, there is a clear case of the CME Fedwatch veering closer to the Fed perspective. This is in sharp contrast to the situation about a couple of months back when the CME Fedwatch view was a lot more aggressive compared to what the Fed was stating. A combination of fall in inflation and a spike in unemployment in the latest reading, gives comfort to the Fed that monetary policy is on the right track. That is likely to goad the CME Fedwatch probabilities in a much tighter range and that is evident in the latest week.

Recap – CME  Fedwatch for the week ended 09-Jun 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	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575
Jun-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	70.1%	29.9%	Nil
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	30.1%	52.8%	17.1%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	2.4%	31.9%	50.0%	15.7%
Nov-23	Nil	Nil	Nil	Nil	Nil	0.9%	14.0%	39.0%	36.5%	9.5%
Dec-23	Nil	Nil	Nil	Nil	0.4%	7.1%	25.7%	37.8%	23.9%	5.1%
Jan-24	Nil	Nil	Nil	0.3%	4.3%	17.9%	32.7%	29.8%	13.0%	2.1%
Mar-24	Nil	Nil	0.2%	3.0%	13.5%	28.0%	30.7%	18.4%	5.6%	0.7%
May-24	Nil	0.2%	2.9%	13.3%	27.7%	30.7%	18.5%	5.8%	0.8%	Nil
Jun-24	0.1%	1.8%	9.1%	21.8%	29.5%	23.5%	11.0%	2.8%	0.3%	Nil

Data source: CME Fedwatch

What did the CME Fedwatch for the previous week ended 09-Jun 2023 depict? It had already hinted at a pause in the Fed minutes and that is something that got ratified in the Fed statement last week. Also, the Fed continues to be very conservative in its communication and wants to keep up the confidence that the Fed would go all out to fight inflation. In a recent speech, Christopher Waller has already stated that Fed policy would focus on price stability and interest rate risk is for the banks to worry about.

Secondly, there is tendency for the market to converge with the Fed view point. About a month or so back, the markets grossly diverged from the Fed on the likelihood of rate cuts in 2023. If you look at the CME Fedwatch expectations being pencilled in, it is betting on a 25 bps hike in rates with an outside possibility of 50 bps rate hike. However, the latter would only happen in a worst case scenario. Also, there is consensus that there would not be any rate cuts in 2023 and that 2024 could see rate cuts of 100 to 125 bps. That means; by end of 2024, the Fed rates would still be much higher than pre-COVID levels.

CME Fedwatch for the latest week ending 16-Jun 2023

Let us now look at how the CME Fedwatch looked as of the latest week i.e., the period ending 16-Jun 2023.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450- 475	475- 500	500-525	525-550	550-575
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	25.6%	74.4%	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	22.5%	68.5%	8.9%
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	0.5%	23.5%	67.3%	8.7%
Dec-23	Nil	Nil	Nil	Nil	Nil	0.2%	7.9%	37.7%	48.3%	5.9%
Jan-24	Nil	Nil	Nil	Nil	0.1%	3.7%	21.5%	42.5%	29.0%	3.2%
Mar-24	Nil	Nil	Nil	Nil	2.2%	14.0%	33.7%	34.7%	14.1%	1.4%
May-24	Nil	Nil	Nil	2.1%	13.4%	32.6%	34.6%	15.2%	2.1%	0.1%
Jun-24	Nil	Nil	1.2%	8.7%	24.7%	33.8%	23.2%	7.5%	0.9%	Nil
Jul-24	Nil	1.0%	7.6%	22.2%	32.4%	24.8%	9.9%	1.9%	0.2%	Nil

Data source: CME Fedwatch

Thematically, the view of the CME Fedwatch looks almost similar to what Jerome Powell said in his post-policy speech. Also, the range of certainty about rate trajectory is now tightening. The expectations in the latest week are rates traversing about 25 bps on the upside and about 100 bps on the downside from the higher levels. So, we could see an interest rate level of 5.25%-5.50% by end of 2023 and a rate of 4.25% to 4.50% as the most likely scenario by the end of 2024. Neither the Fed nor the markets, as depicted by the CME Fedwatch are now betting on the rates going much beyond these levels.

For the Fed, the primary concern continues to be inflation, which at 4% is still 200 bps off the long term target. However, for now the Fed may allow the lag effect to play out. It is still not clear whether July will see a rate hike or the Fed may continue to pause for one more session, but that would depend on the inflation reading for PCE inflation in end-June and the consumer inflation in mid-July. For now, it is over to the data.

Key Fed triggers for 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 sampler.

1. The Fed would keep an eye on the policy action of the other central banks. As of now, the ECB and the Bank of England continue to be hawkish. The Fed would not want to have too much monetary divergence as it has larger implications for currency values.

    

2. With the Fed statement out of the way, the focus next week will be on the Fed Chair Powell’s testimony to the US Congress. Here, he is expected to explain the inflation outlook and also the reason for the rate pause in June policy statement. That is the closest that the markets would get to what the Fed would be doing in its coming policy statements in the rest of the year.

    

3. While consumer inflation is already announced for the month, the next big data point is the PCE (private consumption expenditure) inflation, which is what the Fed uses as a guide to set its policy rates. That is still above the Fed target and the trajectory of PCE inflation would be a key input for the Fed.

    

4. In the coming weeks, the Fed will also focus on final GDP reading for Q1-2024 as well as the unemployment data. They will hold the key to the trajectory in the July policy.

The Fed policy is done and was largely along expected lines. Now, the Fed has made a commitment on peak rates and on the likely range for the next one year. The data flows will become a lot more critical from this point as the world’s largest central calibrates its view.