Market expectations about Fed interest rates can affect the trajectory of the US dollar, Treasury yields, and even stock prices worldwide. Rising expectations of rate hikes tend to drive up the dollar and Treasury yields, while putting downward pressure on the performance of risk assets. Interest rate expectations are therefore a crucial indicator to watch. To that end, the FedWatch rate expectations provide a valuable tool for gauging market trends.

How Are FedWatch Rate Expectations Calculated?

The CME FedWatch Tool forecasts probabilities of interest rate changes based on the 30-Day Fed Funds (ZQ) futures, which are futures contracts listed by the Chicago Mercantile Exchange (CME) with the Effective Federal Funds Rates (EFFR) as the underlying asset.

As the futures are priced based on the market’s expected target rate at the time the contracts expire, the CME FedWatch Tool calculates the implied expected rate across various contract months to reflect the market’s expectations on future FOMC rate decisions.

How to Interpret the Chart?

Composed of two parts, the featured chart provides insights into the expected magnitude and direction of potential rate changes:

Year-end Target Rate Projections: The upper part reflects the market’s expected target rate for the end of 2024 by comparing the expected target rate with the interest rate at the beginning of the year. Expressed in number of rate cuts, the chart shows by how much the market anticipates the Fed will raise/lower rates within the year.
Rate Hike/Cut Probabilities at Next FOMC Meeting: The lower part of the chart displays expected probabilities of a rate hike (or rate cut) at the next FOMC meeting, which is useful for assessing the potential direction of rate changes at the upcoming Fed meeting.

MM Takeaways

As both parts of the chart indicate, the probability of a rate hike within the year or at the upcoming FOMC meeting has been close to zero, suggesting a prevailing market outlook that there will be no interest rate hikes.

Moreover, in the upper part of the chart, the gradual ascent of the red and yellow lines (two cuts and one cut), which have taken the top two positions since April, suggests that a 25-50 basis point cut by the end of 2024 is increasingly becoming the market consensus.

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