Probability of further tightening surges

Kalshi markets forecast another month of 0.5% month-over-month headline CPI growth in February 2023. Such a prediction comes after Kalshi markets accurately forecasted the 0.5% print for January, and after the release of several pieces of information–including upwards revisions to previous months due to seasonal adjustment and hotter-than-expected retail sales numbers–suggest that rapid price growth will continue at least through February. This is roughly congruent with the Cleveland Fed’s NowCast projection of 0.57%. However, it is worth flagging that these hotter-than-previously-projected forecasts do not affect the annual outlook, perhaps due to expectations of further Fed tightening.

These sustained inflationary pressures have spiked the probability that the Fed will hike 50 bp at their March meeting from 4% to 16%, though it remains likely that they will stick to the previously projected 25 bps (84% chance). These odds changed dramatically late on Thursday after comments from Fed St. Louis leader James Bullard (who is not a voting member of the FOMC) suggested he was partial to a 50 bp hike even at the previous meeting. Kalshi markets are similarly confident (82%) that the federal funds target range will reach 5.00-5.25% at the May meeting (50 basis points above today), up from 80% on Friday February 10 and 47% at the start of February.

The risk of even further tightening has increased substantially in recent days. The odds of 5.25-5.50% or above at the June meeting have surged from 13% in early February to roughly 62% today. Meanwhile, the probability that the Fed will ultimately need to cut rates in 2023 has halved from the start of February to today, where it sits at roughly 15%.

Kalshi markets forecast the unemployment rate to rise slightly to 3.5%, but with a 90% confidence interval of 3.3%-3.6%. 2023 Q1 growth, meanwhile, is likely to remain positive at ~1.5% (slightly below the forecast of 2.4% from the Atlanta Fed’s GDPNow forecast, but well above the Blue Chip consensus number. The probability of two consecutive negative quarters of GDP growth, meanwhile, has remained stable at around 50%.

The “whisper” number is a private, unofficial number that is circulated by bank analysts to their clients, including high net-worth individuals, Wall Street traders and hedge funds during the blackout period after the official consensus is published and before data is released. Analysts and economists at banks continue to revise their estimates during the blackout period, but share their new forecasts with a limited clientele. They call these late forecasts “whispers” because they’re not public and not broadly accessible. Kalshi forecasts serve as a more accessible market-driven “whisper” during the blackout period, before the release tomorrow.

The Kalshi Whisper comes from market prices based on CPI, core CPI, target fed funds markets and other relevant Kalshi markets. Markets are purely directional: traders purchase binary contracts on a central-limit order book that pay out based on conditions such as “CPI inflation exceeds 0.2% in November 2022”. From these contracts, one can simply extract the probability of any given release. For example, the probability of CPI inflation equaling 0.2% is equal to the price that CPI inflation exceeds 0.1% subtracted by the price of CPI inflation exceeding 0.2%. Current projections are based on the last traded price for contracts. Federal funds rate projections come from binary markets that pay out on the basis of the upper bound of the Federal Funds target range.

Kalshi markets have a history of accuracy. The median Fed projections have correctly identified the size of the rate hike for each meeting since the first Kalshi Fed projection in July 2021. The median CPI forecasts have been equally accurate or more accurate than the Bloomberg economist survey and the Cleveland Fed Nowcast in 10 of the last 12 months.

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