Lately, This Chart Is Making The Rounds

Lately, This Chart Is Making The Rounds
Luke Suddards

over 1 year ago3 mins

This chart shows the World Interest Rate Probabilities (WIRP) and you’re bound to come across it somewhere – it’s all over LinkedIn, Twitter, and Reddit. It offers a quick snapshot of where investors expect the US benchmark rate to be after each of the Federal Reserve’s (the Fed’s) meeting dates. It’s useful – and packed with information. Speculators can place their bets based on whether they believe the market is pricing too few or too many interest rate hikes. Central bankers can quickly see how the market is thinking with regards to their future rate decisions, and can use their speeches to correct too-hawkish or too-dovish expectations. What’s more, key interest rates such as mortgages are also priced off these figures.

The Meeting column simply shows the Fed’s meeting schedule. The #Hikes/Cuts column tells us the cumulative amount of hikes/cuts investors expect at each meeting date. So for example by March 22nd, 2023, investors are expecting 7.285 rate hikes of 0.25 percentage points, for a cumulative 1.821 percentage-point increase on today’s benchmark rate. The %Hike/Cut column attaches a probability based on what’s priced for a specific meeting, measuring expectations in 0.25 percentage point increments. In the first row, it reads as 313% – which represents the fact that investors expect a rate hike that’s at least three times that size: a rate hike of 0.783 percentage points, to be precise.

The Implied Rate Δ (change) is the really important column. It tells you that at the Fed’s upcoming November meeting investors are expecting a hike of 0.783 percentage points. To work out what investors see as the rate move at the following meeting you would take 1.401 and subtract 0.783, leaving you with a 0.618 percentage-point hike. Now if you wanted to calculate the probability of a 0.75 percentage point hike at the December meeting, you would take 0.618 and divide it by 0.75 to get 0.824, and then multiply by 100 to convert it into a probability of 82.4%. So basically the market sees a high chance for a back-to-back 0.75 percentage point rate hike in November and December. The Implied Rate column shows us what investors expect the Fed’s benchmark rate to be at each meeting. If we go down to the fourth row, we can see the market expects a rate of 4.903% as of March 22, 2023. Looking at the Implied Rate Δ column to the left gives us a figure of 1.821. That means the market expects 1.821 percentage points of hikes between now and late March. The final column ARM stands for assumed rate move and in this case, is set at 0.25% increments for hikes or cuts.

From this table, you can quickly work out what the Fed’s terminal, or peak, rate is expected to be. In this case, it’s 4.903%. In other words, investors see the Fed raising its benchmark fed funds rates to just shy of 5%, before it begins cutting them. Those future cuts are implied by the December 13th, 2023, contract, which is priced at 4.548% (for roughly 0.355 percentage points in cuts).

This is where the Fed and the market may diverge as the Fed may not begin cutting rates and could instead keep them elevated at higher levels for longer, if inflation lingers.

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