According to FedWatch, a monetary policy analysis tool of the Chicago Mercantile Exchange (CME), the expected probability of the first interest rate cut in September was about 71.8% before the release of the June CPI data. After the release of the CPI data, the expected probability of the first interest rate cut in September was about 88.1%.
On the surface, the probability of 71.8% is not low. If it rises to 88.1%, how can we talk about a reversal?
†Letâs take a look at a comparison
The current expectation is that there is an 88.1% probability of the first rate cut in September (that is, the interest rate is 5%~5.25%).
According to the Federal Reserveâs interest rate policy in recent years, there is a high probability that interest rate hikes or cuts will be implemented continuously in the early stages.
In other words, once the interest rate cuts begin, there is a high probability that they will continue in the early stages, and they will not stop and cut again.
According to this assumption, if the interest rate in September is 5%~5.25%, then the interest rate in November should be 4.75~5%.
However, the expected probability of a monthly interest rate of 4.75% to 5% in November has dropped to 56.8%.
There are some contradictions in the difference from 88.1% to 56.8%.
The 88.1% expected probability of a first rate cut in September may just be an appearance.
â€Assumption of continuous rate cuts
The probability of a continuous 25 basis point rate cut in the early stage of the rate cut is high. Based on this consideration, the interest rate forecasts for the first rate cuts in September, November and December are as follows:
Next, we use this probability to determine the expected probability of the first interest rate cut in the next few months:
†Before the release of CPI data (expected value on July 9)
âIf the first rate cut is in September
Current interest rate: 5.25~5.5%
September interest rate: 5~5.25%, expected probability: 71.8%
November interest rate: 4.75~5%, expected probability: 30.7%
December interest rate: 4.5~4.75%, expected probability: 25.8%
January interest rate: 4.25~4.5%, expected probability: 17.1%
âIf the first rate cut is in November
Current interest rate: 5.25~5.5%
September interest rate: 5.25-5.5%
November interest rate: 5~5.25%, expected probability: 53%
December interest rate: 4.75~5%, expected probability: 47.4%
January interest rate: 4.5~4.75%, expected probability: 40.1%
March interest rate: 4.25~4.5%, expected probability: 32.7%
âIf the first rate cut is in December
Current interest rate: 5.25~5.5%
September interest rate: 5.25-5.5%
November interest rate: 5.25-5.5%
December interest rate: 5~5.25%, expected probability: 22.5%
January interest rate: 4.75~5%, expected probability: 31.3%
March interest rate: 4.5~4.75%, expected probability: 33.8%
†After the CPI data is released (July 15 expected value)
In order to wait for the CPI to be released, the data on the morning of July 15th, Beijing time, was selected, when the United States was still in non-working hours.
âIf the first rate cut is in September
Current interest rate: 5.25~5.5%
September interest rate: 5~5.25%, expected probability: 88.1%
November interest rate: 4.75~5%, expected probability: 56.8%
December interest rate: 4.5~4.75%, expected probability: 49.8%
January interest rate: 4.25~4.5%, expected probability: 37.6%
âIf the first rate cut is in November
Current interest rate: 5.25~5.5%
September interest rate: 5.25-5.5%
November interest rate: 5~5.25%, expected probability: 37.7%
December interest rate: 4.75~5%, expected probability: 40.1%
January interest rate: 4.5~4.75%, expected probability: 42.6%
March interest rate: 4.25~4.5%, expected probability: 41.6%
âIf the first rate cut is in December
Current interest rate: 5.25~5.5%
September interest rate: 5.25-5.5%
November interest rate: 5.25-5.5%
December interest rate: 5~5.25%, expected probability: 7.3%
January interest rate: 4.75~5%, expected probability: 15.8%
March interest rate: 4.5~4.75%, expected probability: 21.1%
†Qualitative comparison before and after the rate cut
After making a table, it will be more obvious:
â Qualitative comparison
As shown in the figure, before the release of the June CPI data, the probability of the first rate cut in September was 71.8%; the probability of the first rate cut in November was only 53%. However, in reality, based on the expectations from November to January 25, the first rate cut in November is more likely to be expected.
However, after the CPI was released, it was clear that the expectation of a rate cut in September was higher. The expectations for September-December were all for the first rate cut in September.
†Quantitative comparison before and after the interest rate cut
We can consider that those who expect interest rates to fall continuously have firm expectations, while those who expect interest rates to fall discontinuously have unfirm expectations.
That is, those who simultaneously expect the interest rate to be 5-5.25% in September, 4.75-5% in November, 4.5-4.75% in December, etc., are firmly convinced that the first interest rate cut will take place in September.
We can compare the probabilities of firm expectations.
âBefore CPI data is released
âą If we calculate the expected probability product for 2 consecutive months:
The probability of a firm expectation of the first rate cut in September
=71.8%*30.7%=22.04%
Probability of a firm expectation of the first rate cut in November
=53%*47.4%=25.12%
âą If we calculate the expected probability product for three consecutive months:
The probability of a firm expectation of the first rate cut in September
=71.8%*30.7%*25.8%=5.69%
The probability of a firm expectation of the first rate cut in November = 53%*47.4%*40.1%=10.07%
âAfter the CPI data is released
âą If we calculate the expected probability product for 2 consecutive months:
The probability of a firm expectation of the first rate cut in September
=88.1%*56.8%=50.04%
Probability of a firm expectation of the first rate cut in November
=37.7*40.1%=25.12%
âą If we calculate the expected probability product for three consecutive months:
The probability of a firm expectation of the first rate cut in September = 88.1%*56.8%*49.8%=24.92%
The probability of a firm expectation of the first rate cut in November = 37.7*40.1%*42.6%
=6.44%
â€Comparison conclusion
From the perspective of the highest expectations for each month, it can be seen that after the release of the CPI data, the market's expectations for the first rate cut have reversed. Previously, the first rate cut was expected to be in September, but in fact the greater expectation was November. However, after the release of the June CPI, the market expected the first rate cut to be in September.
The firm expectation probability proposed in this article can quantitatively show the reversal of this expectation.
â€Written at the end
This article mainly proposes a method of "observing the expected probability of consecutive time points" to relatively effectively analyze the market's real expectations of interest rate cuts.
As far as the current market environment is concerned, there is no new conclusion. After all, everyone has no doubts about the high probability of the first interest rate cut in September.
However, the next two time points:
First, the new FOMC meeting of the Federal Reserve on July 31;
Second, the CPI data was released on August 14;
This method can be used as a reference when other events occur and everyone is paying attention to changes in expectations of interest rate cuts.
Paying attention to continuous interest rate expectations will be more effective than looking at expectations for a particular month alone, and will prevent you from being misled by the superficial data of expectations for a particular month.