Weekly Musings – How CME Fedwatch changed for the week to June 30, 2023

2 Jul 2023 , 11:52 AM

These factors were; Powell Speak, the PCE inflation data and the Q1 GDP third estimate. Now, the CME Fedwatch captures the probabilities of rate hikes over the next 10-12 FOMC meetings. These are probabilities that are derived from the Fed Futures trading. The futures price is taken as 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. 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%. CME Fedwatch is hinting at 2-3 more rate hikes of 25 bps each in a worst scenario while 1-2 rate hikes is a more likely scenario. First a recap of the previous week.

Recap – CME  Fedwatch for the week ended June 23, 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	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

The week prior to the latest week had key data points like the Powell testimony to the Congress and the all-important decision by the Bank of England to hike rates by 50 bps. The Powell testimony had 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. Clearly, Fed will go all out to fight inflation. It is not just about price stability but also about anchoring inflation expectations in the US and around the world. In the last June FOMC meet, the Fed had opted to pause on rate hikes. However, the Fed had made it clear that it was only a pause and that rate hikes would resume from July onwards.

What we read from the CME Fedwatch in the week to June 30, 2023

Let us now look at how the CME Fedwatch evolved during the latest week i.e., the period ending June 30, 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	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

Let us now turn to the 3 factors that influenced the CME Fedwatch probabilities in the latest week. Firstly, the PCE inflation on a yoy basis came in sharply lower by 50 bps at  3.8% for May 2023 compared to 4.3% in April. However, the core PCE inflation fell by just 10 bps and most of the fall came from food and energy. Secondly, the US GDP third estimate for Q1 was upgraded by 70 bps to 2%. That assured the Fed that the chances of a full-fledged recession were diminishing, if not vanishing. What really mattered was the Fed speech on June 27, 2023 which clearly underscored that the Fed was not done with hikes. The rate pause in June was only to allow the macros time to catch up with the Fed action.

How did the CME Fedwatch probabilities shift during the week to June 30, 2023. The underlying story is broadly the same. However, some of the probabilities with a hawkish bias have got reinforced during the week. Let me illustrate a few cases here. The latest probabilities indicate that 25 bps rate hike in July is almost inevitable now. 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. The bias is clearly hawkish and it appears to be a case of the markets buying the Fed talk and toeing the Jerome Powell line of thinking. On the downside, rate hikes were already ruled out in 2023. Now, even in 2024, the rate hikes do not look like to go below the range of 4.50% to 4.75%. That is still well above the long period median.

Triggers to watch out for 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. For the US markets, it will be a truncated week due to the US Independence Day holiday on July 04, 2023. On July 03, 2023, the high frequency PMI data for manufacturing will be put out. That will give an idea if there are any pressures on the manufacturing front in the short term. Apart from the PMI Manufacturing data, the trade data is also expected to be announced later in the week. That will give an idea about how the US trade is being impacted by fears of recession across the globe.

    

2. The all-important FOMC minutes of the June meeting will be published on July 05, 2023. The minutes not only show the detailed dot plot of future expectations but also document the detailed discussions among the members of the Federal Open Markets Committee (FOMC). This gives richer insights into the likely Fed action and rates trajectory. After all, the Fed does take its communication very seriously and that adds more credibility to the reading of the minutes.

    

3. In the coming weeks, the Fed will also keep an eye on what other central banks are doing on the monetary management front. For now, there appears to be a dichotomy with the central banks of Japan, China and India preferring to go easy on monetary tightening while the US, EU, and UK till are in the hawkish zone. They also want a growth focus and the US will have to take a call on whether focus on price stability is sufficient. The pause is a signal that there is a serious rethink going on.

Needless to say, India will be closely watching 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. The question is whether further rate hikes would be data driven or would it be front-ended to get done with the hawkishness. 

Hiking rates is always a dilemma as it is a trade-off between controlling inflation and keeping room for future inflation. 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, will surely have a major bearing on the thinking of the RBI too. How the RBI acts will be an India story.