Weekly Musings – How CME Fedwatch changed for the week to June 23, 2023

26 Jun 2023 , 10:09 AM

Most of the data points for the CME Fedwatch were announced in the week prior to the current week. The US consumer inflation came in sharply lower at 4.0%, albeit still 200 basis points higher than the eventual target of 2%. In addition, the Fed had also announced a temporary pause on rate hikes This was significant because it came after 15 months and 10 consecutive rate hikes between March 2022 and May 2023. In this period, the Fed rates had gone from the range of 0.00%-0.25% to 5.00%-5.25%, a spike of 500 basis points.

However, there were two factors that reinforced the hawkishness still implicit in the markets. Firstly, the Fed in its statement had underlined that it was not done with rate hikes and even hinted at another 2 rounds of rate hikes of 25 bps each in the current year. That was essential to curb any traces of inflation. Secondly, the Bank of England hiked rates by 50 bps to 5%, to counter the highest levels of inflation seen in the UK since the 1980s. This has resulted in the CME Fedwatch expectations also turning slightly more hawkish.

Recap – CME  Fedwatch for the week ended 16-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
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

What did the CME Fedwatch for the previous week ended 16-Jun 2023 depict? The week to June 16, 2023 was marked by two important data points. The Fed policy statement was announced by Jerome Powell and the consumer inflation data also came out during the week. Both were favourable for the market and that should have ideally helped the CME Fedwatch to get less hawkish. However, the Fedwatch ended up becoming more hawkish as it read closely into the fine print of the Fed statement. Jerome Powell had clearly underlined that they were not done with rate hikes. He had even hinted at 2 more rate hikes of 25 bps each. 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. It is not just about price stability but also to anchor inflation expectations in the US and around the world.

The other major data point in the previous week was the consumer inflation data for May 2023. One argument is that consumer inflation may not be too relevant since the Fed uses PCE inflation as the data point to crystallize its view on the future trajectory of rates. That number normally comes in the last week of the month only. For the month of May 2023 US consumer inflation had fallen 90 bps to 4%. While this is appreciable, there are two causes of concern. Firstly, while the yoy inflation has been falling, the MOM inflation has been showing pressure on and off. Secondly, while fuel inflation and food inflation have come down remarkably well, it is core inflation that is not coming down in the US.

CME Fedwatch for the latest week ending 23-Jun 2023

Let us now look at how the CME Fedwatch looked as of the latest week i.e., the period ending 23-Jun 2023.

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	28.1%	71.9%	Nil	Nil
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	23.6%	64.9%	11.5%	Nil
Nov-23	Nil	Nil	Nil	Nil	Nil	Nil	20.9%	60.2%	17.6%	1.3%
Dec-23	Nil	Nil	Nil	Nil	Nil	6.6%	33.3%	46.7%	12.4%	0.9%
Jan-24	Nil	Nil	Nil	Nil	3.6%	21.0%	40.5%	28.3%	6.2%	0.4%
Mar-24	Nil	Nil	Nil	2.2%	14.4%	33.1%	32.9%	14.6%	2.6%	0.2%
May-24	Nil	Nil	2.1%	13.8%	32.2%	32.9%	15.5%	3.2%	0.3%	Nil
Jun-24	Nil	1.1%	8.2%	23.4%	32.6%	23.8%	9.1%	1.7%	0.1%	Nil
Jul-24	0.9%	7.0%	20.7%	31.0%	25.4%	11.6%	3.0%	0.4%	Nil	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. There were two triggers for the CME Fedwatch during the week. The first was the Powell testimony before the US Congress. While expressing confidence that higher rates would not hit the growth momentum, Jerome Powell also underlined that price stability was their core commitment and they would stick to it. Secondly, the Powell testimony also underlined that the Fed stayed hawkish, despite the pause. If hawkishness created risks for banks, it was up to the board to manage it.

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. However, an interesting change has happened in this month. With the Fed staying hawkish, the markets are now pricing in a new scenario of rates even going as high as 5.75% to 6.00% range in the current year. The probability may be low, but the CME Fedwatch appears to be preparing the markets for more hawkishness than envisaged.

US inflation is still 200 bps away from the target rate of 2% and till that time the Fed is likely to remain on the hawkish side. The big data point in the coming week will  be the PCE inflation, which is considered to be the basis for rate action. Then there is the all-important first quarter GDP numbers that will also be announced towards the end of the week to enable markets to take a call on inflation and growth. 

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. There is the final estimate for the Q1 GDP that will be put out in the coming week. The markets would look for upgrades in growth, although that does look impractical.

    

2. PCE (private consumption expenditure) inflation will be the big data point to watch out for this week. PCE inflation had been trending lower but this money will be crucial to see if it really impacts the dynamics of the market. Here again, it is the core inflation part of PCE that seems to be a lot harder to bring down.

    

3. In the coming weeks, the Fed will also keep an eye on the other central banks. Clearly, there appears to be a dichotomy with the central banks of Japan, China and India preferring to reduce the involvement of the central bank in tightening. They also want a growth focus and the US will have to take a call on whether focus on price stability is sufficient.

The Fed chair, Jerome Powell, will also be speaking in the coming weeks on a number of factors that influence the rates trajectory. The Fed policy is done and was largely along expected lines. It is now up to the Fed chair to explain the nuances of the policy statement and extrapolate it to rate action. For the CME Fedwatch, it appears to be increasingly converging towards the Fed view.