Weekly Musings – How CME Fedwatch changed for the week to June 2

5 Jun 2023 , 08:35 AM

Before we go ahead, it would be instructive to know that the CME Fedwatch has been the best gauge of how the US markets view the interest rate trajectory of the Fed. These can be interpreted as the probabilities of rate hikes / rate cuts by the Fed over the next 8-10 Fed meetings. These probabilities are culled from the fed futures trading data. In short, the fed futures prices are taken as the intrinsic value and the implied probabilities are calculated based on that. Let us turn to the big drivers of the shift in CME Fedwatch during the week ended 02^nd June 2023? It was certainly less of an eventful week, compared to the prior weeks, when CME Fedwatch saw bouts of volatility.

What impacted CME Fedwatch probabilities in the week to 02nd June?

Fed data flows have been rather confusing in the last few weeks. For instance, the GDP growth for the March quarter came in lower than expected at 1.1% as per the first advance estimate, but was upgraded to 1.3% in the second estimate. The PCE inflation for April 2023 was subdued on a yoy basis, but the high frequency MOM inflation stayed elevated at 0.4%. The labour data remains strong with unemployment at record low levels of 3.4%. Amidst all these diverse data signals, the Fed has given a rather unequivocal indication of a pause rate hikes in June 2023. 

While Powell did dwell upon the same in the minutes of the FOMC meeting, subsequent statements by the various regional Fed governors also appears to substantiate the view. However, it is still too early to surmise whether the pause in June would be a temporary distraction or a signal of the future trajectory of rates. The next few weeks are likely to see more decisive moves in Fed probabilities as monetary clarity emerges.

Recap – CME  Fedwatch for the week ended 26th May

Here is a quick recap of how the CME Fedwatch looked like for the previous week, before the above data points 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	35.8%	64.2%	Nil
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	20.7%	52.2%	27.1%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	4.5%	27.6%	46.7%	21.1%
Nov-23	Nil	Nil	Nil	Nil	Nil	2.4%	16.6%	37.6%	33.3%	10.0%
Dec-23	Nil	Nil	Nil	Nil	1.2%	9.7%	27.5%	35.4%	21.3%	4.9%
Jan-24	Nil	Nil	Nil	0.8%	6.7%	21.1%	32.5%	26.4%	10.8%	1.8%
Mar-24	Nil	Nil	0.6%	5.3%	17.6%	29.8%	27.9%	14.5%	3.9%	0.4%
May-24	Nil	0.8%	5.8%	18.2%	29.7%	27.3%	14.1%	3.8%	0.4%	Nil
Jun-24	0.5%	3.8%	13.1%	25.0%	28.3%	19.5%	8.0%	1.8%	0.2%	Nil

Data source: CME Fedwatch

What did the CME Fedwatch for the previous week ended 26th May depict? It has hinted at a pause in the Fed minutes but the undertone of the Fed appeared to be that it was not done with rate hikes. As of the close of the week to 26th May 2023, the CME Fedwatch was hinting at a worst case possibility of 50 bps rate hike and a very likely scenario of another 25 bps rate hike. That means; in the most likely scenario, the Fed rates would top out in the range of 5.25% to 5.50%. Even as the Fed appeared intent on a rate pause in June, the data flows remained mixed in the prior week. High frequency inflation at the PCE level remained still high, core inflation refuses to come down rapidly while GDP growth has slowed, but is far from indicating a clear recession. That was the CME Fedwatch scenario in the prior week.

CME Fedwatch for the latest week ending 02nd June

Let us now look at how the CME Fedwatch looked as of the latest week i.e., the period ending 26th of May 2023.

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	74.7%	25.3%	Nil
Jul-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	32.1%	53.5%	14.4%
Sep-23	Nil	Nil	Nil	Nil	Nil	Nil	3.9%	34.7%	48.8%	12.7%
Nov-23	Nil	Nil	Nil	Nil	Nil	2.0%	19.6%	41.9%	30.4%	6.2%
Dec-23	Nil	Nil	Nil	Nil	1.0%	10.9%	30.8%	36.1%	18.2%	3.1%
Jan-24	Nil	Nil	Nil	0.8%	8.5%	26.1%	34.8%	22.4%	6.6%	0.7%
Mar-24	Nil	Nil	0.7%	7.4%	23.7%	33.6%	24.1%	8.8%	1.6%	0.1%
May-24	0.1%	1.7%	10.0%	25.3%	32.1%	21.7%	7.7%	1.3%	0.1%	Nil
Jun-24	1.3%	7.1%	20.0%	29.7%	25.3%	12.6%	3.5%	0.5%	Nil	Nil

Data source: CME Fedwatch

Two things appear to have crystallized in the latest week. Now, the markets appear to be convinced that rate hikes from these levels could be restricted to 25 bps at best and the possibility of the end of hawkishness could not be ruled out. Secondly, the markets are still betting on rate cuts, but they now expect it to get back-ended to 2024, instead of 2023. Also, markets are now betting on a 100 bps rate cut as a best case scenario in 2024, as against the 200 bps rate cut expectation just about 2-3 weeks ago. They see the current range of interest rates between 4.00% an 5.25% more as a medium term equilibrium rate of interest and Fed may stay in this range for much longer than originally anticipated.

So, is the market more hawkish or more dovish in the week to 02nd June 2023, as compared to the previous week. Actually, it is neither. What appears to have crystallized is a medium term range of about 125 bps wherein the rates are expected to oscillate. But, the week was also the return of pragmatism in the CME Fedwatch. In the previous weeks, the CME Fedwatch appeared to be opposed to the signals and statements coming from the Fed. Now, the CME Fedwatch appears to be reflecting the Fed line of thinking a lot more.

Key Fed triggers for the week to 02nd June 2023

A week may be a short time to judge the change of trajectories, but the CME Fedwatch being sensitive, a lot can happen and change in a span of just one week. However, it must be said that the latest week has been relatively subdued compared to the previous two weeks. That was more due to the absence of any explicit data flows.

1. When it comes to the Fed, the communication and dissemination matters a lot. It was not just that the Fed minutes had hinted at a pause in June. That point has been underlined in every forum and by every senior Federal Reserve speaker. That adds lot more credibility to the view that the Fed would pause on rates. That is reflected in the marginal shift in probabilities, especially in the near month probabilities.

    

2. During the week, a lot more clarity emerged on the peak rates of interest. Till the last week, the rate hike probabilities stood at a very likely 25 bps and a possible 50 bps. Now the probabilities are almost divided between 25 bps rate hike and Fed rates already having peaked in the range of 5.00% to 5.25%.

    

3. Even though the view is of a pause in rates in June, we have to await the actual decision since the proof of the pudding lies in the eating. Between now and the middle of June when the Fed policy statement will be announced, data points like the jobs data and the consumer inflation data will have a key role to play. Rate pause looks like a done deal, but remember; policy shifts are never going to be an easy decision.

    

4. The good news is that the Fed may be nearing its definition of peak interest rates. The bad news is that nobody knows how the Fed would react to other macro stimuli. The first ratification may come when the jobs data come in the early part of June.

Last week, the resolution of the debt ceiling was always a done deal, so it hardly impacted the CME Fedwatch. Going ahead, inflation, jobs and GDP growth could hold the key to rates trajectory.