Kalshi and CME Diverge on Rates Expectations

Kalshi market expectations of Federal Reserve behavior this year are increasingly off from Fed Futures’. While both have increasingly soured on more rate hikes (with a mere 38% chance that the Federal Reserve moves the target rate range to 5.25-5.5% at the June meeting), CME’s Fed Futures aggressively position the rate range to fall this year. By end-of-year, Kalshi expects the target rate range to be close to the status quo, with only one more net rate hike. Fed Futures project the rate to be ~75 bp lower, pricing in an extremely high probability of a rate cut. On Kalshi, the probability of a rate cut has remained stable, at 47%. By the end of 2024, Fed Futures are now pricing in a significant fall in rates, with the most likely rate range being 3.00-3.25%.

Kalshi markets project the Federal Reserve to raise the target federal funds range in May to 5.00-5.25%, representing a 25 bp increase from the current 4.75-5.00% range. The probability of such a 25 bp hike is roughly 91% (around 10% more than last week’s probability), with a ~9% probability of a rate pause, and a 1% probability of either a cut or a larger hike. CME’s FedWatch tool gives similar probabilities for May, with a 86% probability of a 25 bp hike and a 14% probability of a pause.

The probability of a 25 bp rose as several Fed officials, including New York President John Williams and Atlanta President Raphael Bostic, signaled their support for another rate hike; however, there was a sudden drop mid-week in long-term expectations as Bostic and other reports suggested that an extended pause on hikes may follow the May meeting. Since the last meeting, projections have been extremely volatile–particularly through the Silicon Valley Bank debacle and the March employment situation–to land at a very strong consensus almost two weeks out.

Though the current ‘X’ date is unclear, the Congressional Budget Office projected government spending to cross the debt ceiling somewhere between June and September, with Janet Yellen specifically identifying early June. However, Kalshi markets project only a 23% chance that the debt ceiling is lifted by June 9th, and only a 42% chance it’s lifted by July 1st. Markets are confident, however, that it will be done by August 1 (71%). The odds of the debt ceiling being lifted by year-end on Kalshi have become extremely high, near 95%, from a low of 75%. Nonetheless, and most worryingly, odds that the U.S. will default have remained very stable, at 11%.

Headline CPI inflation for April came in at 0.1%, with housing CPI finally slowing down, below Kalshi’s 0.21% projection. Kalshi projects headline CPI inflation to reach 0.42% (month-over-month) in the month of April, almost identical to last week’s 0.41%. This number, however, is increasingly divergent from the Cleveland Fed’s Inflation Nowcasting tool, which projects 0.59% month-over-month CPI inflation (compared to 0.54% last week). Kalshi markets estimate a 49% chance that inflation will be at least 0.5% in April, and a 20% chance of at least 0.6%+ (stable from last week). Modal expectations of core inflation, which strips out volatile energy and food prices, have had a similar modest fall from 0.46% to 0.34% with the probability of 0.5% or above standing at 27% (down from 41% last week). Annual inflation expectations, meanwhile, fell slightly to 4.01%, below last week’s 4.05%.

Odds of a recession fell significantly this week, with Kalshi traders projecting a 38% chance of two consecutive quarters of negative GDP growth sometime in 2023, a drop from last week’s 44%. Probabilities have traditionally been in the 35-45% range. Meanwhile, the Q1 GDP forecast grew again this week to 2.15%, up from 1.8% last week and 1.56% the week before that. The Atlanta GDPNow forecast jumped from to 2.5% in that time.

Two consecutive quarters of negative GDP growth

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 11 of the last 13 months.

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