The CME Group FedWatch Tool has long been the reference for traders, journalists and market participants at large looking to understand the expectations for U.S. monetary policy rates. By referring to CME Group’s deep and liquid market for Fed Funds futures, the CME FedWatch Tool can translate market prices into expectations for the level of rates in the future and, consequently, any hikes or cuts that the Federal Reserve might make to its target rate.

In accordance with the CME Group mission to provide better tools for understanding interest rates markets, we recently launched an enhancement to the CME FedWatch Tool - the aggregated view.

The traditional “Conditional” view of hike/cut probabilities for each FOMC meeting calculates the implied change in rates for a given month, in relation to the rates implied for the prior and following months. By contrast, the new “aggregated” view calculates those rates in relation to the current target range.

Let’s illustrate this with a hypothetical example. Suppose today is May 1 and there are scheduled FOMC meetings in June and July. These are the current prices and implied rates of CME Group Fed Funds futures:

May FF future (ZQK4): 94.875 | 5.125%
June FF future (ZQM4): 94.750 | 5.250%
July FF future (ZQN4): 94.625 | 5.375%

The implied probability of a hike in June is [(5.250% - 5.125%) / 0.25%] = 50%.

Individual FOMC Meeting Probabilities
Meeting Date No Change One 25 bp Hike
June 2024 50% 50%

Let us now calculate the probabilities for the July meeting under the “conditional” approach: [(5.375% - 5.250%) / 0.25%] = 50%. This approach calculates probabilities which are conditional on the rates implied by the June contract.

Individual FOMC Meeting Probabilities (Conditional Approach)
Meeting Date No Change From Prior Month One 25 bp Hike Compared to Prior Month
June 2024 50% 50%
July 2024 50% 50%

Now we can build the conditional matrix of where rates might land in the future:

Conditional FOMC Meeting Probabilities
Meeting Date No Change (5.00% - 5.25%) One 25bp Hike (5.25% - 5.50%) Two 25bp Hikes (5.50% - 5.75%)
June 2024 50% 50% -
July 2024 (50% * 50%) = 25% (50% * 50%) + (50% * 50%) = 50% (50% * 50%) = 25%

As shown above, the July probabilities are calculated by tracing all the possible paths that rates can take based on the individual meeting probabilities. In order to have no rate change by the end of July, you would need the 50% chance of no change in June and the 50% chance of no change in July both to be true. Conversely, in order to see precisely one 25 bp hike by the end of July, you could either see no change in June and a hike in July, or the inverse: a hike in June and no change in July. Finally, the conditional view indicates that there is a small chance that you would see two 25 bp hikes by the end of July, if a hike happens in each of the June and July meetings.

This is, of course, one valid way to interpret the price signals from the Fed Funds futures contracts. An alternative way to interpret these signals is the “aggregated” view of rate changes. In practice, this means not compounding the individual meeting probabilities of hikes/cuts but, rather, calculating the number of hikes or cuts priced in by a given point in time in the future in comparison to the current rates.

Let us recalculate the individual meeting probability for July, but now under the “aggregated” approach. Comparing the rate implied by the July contract with the current rate implied by the May contract, we have: [(5.375% - 5.125%) / 0.25%] = 100%. This can be interpreted to mean that the market is pricing in exactly one 25 bp hike between May and July.

Aggregated FOMC Meeting Probabilities (as of May 1)
Meeting Date No Change From May One 25bp Hike Compared to May
June 2024 50% 50%
July 2024 - 100%

The aggregated view of Fed Funds futures implied probabilities indicates that the market is pricing in a hike by the end of July, but it is uncertain of when that hike may take place. The prices imply a 50% chance of this hike taking place in June, and a 50% of it taking place in July. Thus leading to the interpretation of a 100% chance of one 25 bp hike by the end of July being priced in by the market.

By comparing and contrasting both views, one can get a more well-rounded understanding of market expectations on the magnitude and timing of U.S. policy rate changes. The CME FedWatch Tool facilitates this comparison via the “Probabilities” tab, shown below (with numbers as of May 2, 2024):

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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