Economic smoke clears on chaotic week

After a week of changing rapidly day-by-day, Kalshi’s forecast for the March 22 Fed announcement has coalesced around a 25 bp hike to 4.75-5.00%. The probability of a 25 bp hike is now 84%, with the probability of 50 bp declining to 3% and the probability of 0 bp falling to 13%. To recap last week’s events, the probability of a rate pause stood at 1% on Thursday and a mere 3% on Sunday morning before surging to 26% soon that evening. The release of slightly higher-than-expected core inflation contributed to the halving down to 13.% Conversely, the probability of a more aggressive 50 bp hike stood at 18% early last week, before skyrocketing to 54% after comments from Federal Reserve chairman Jerome Powell. The collapse of Silicon Valley Bank and Signature Bank caused the probability to collapse to 6% over the weekend, before settling at 3% after the release of the inflation report (which, while still high, was not sufficiently above expectations to revise the need for 50 bp).

Probability of a 25 bp hike is...84%

This chart represents the Kalshi markets probability that the fed funds target range rises to 4.75-5.00% after the March meeting

The long-term rate outlook has changed dramatically as well. The probability of a rate cut sometime in 2023 has jumped from 16% before last week’s events to 49% today. It stood at 40% at the start of the week. Meanwhile, the forecasted Fed target range for each meeting has shifted downwards. The May meeting median forecast is now 5.00-5.25% (with a near even chance for 4.75-5.00%), down from Thursday’s projection of 5.25-5.50%. The June forecast is down even further, from 5.50-5.75% to 5.00-5.25%. The December forecast, notably, now projects 4.75-5.00%. Before last week, the forecast was 5.50-5.75%.

The probability of a rate cut in 2023...49%

Kalshi’s forecast for February inflation was near spot on. Markets correctly forecasted headline month-over-month inflation to hit 0.4% (year-over-year 6.0%) and mildly undershot on core inflation, which Kalshi projected at 0.4% instead of the true value of 0.5%. Looking forward, Kalshi projects headline inflation to slow to 0.2% (month-over-month) in the month of March. This number is below the Cleveland Fed’s Inflation Nowcasting tool, which projects 0.30% month-over-month CPI inflation. That said, Kalshi markets estimate a 46% chance that inflation will reach 0.3%+, and a 20% of 0.4%+, so higher numbers are not entirely out of the picture. Expectations of core inflation, which strips out volatile energy and food prices, have risen to 0.4% with the probability of 0.5% or above standing at 36%. Annual inflation expectations have increased to 3.69%, the highest value since January 10. These numbers have increased dramatically in recent weeks. After promising data released in January and early February, market forecasts bottomed out at 3.16% before rising over the course of late February and early March. Before last week, the projection stood at 3.39%. But the combination of elevated core inflation in the February inflation report combined with expectations of a slowed pace of tightening have contributed to expectations of a rising annual inflation rate.

2023 US annual inflation is forecasted to be... 3.69%

Despite this weekend’s action, the probability of a recession has not changed. Kalshi traders project that there is a 43% chance of two consecutive quarters of negative GDP growth sometime in 2023, which has been roughly stable since November 2022. Kalshi markets do expect the March jobs report to report lower numbers than February and January, with a forecast of 182,000 new jobs created. The Q1 GDP forecast remains unchanged at 2.34%. This projection mostly splits the difference between the Atlanta GDPNow forecast of 3.2% and the Blue Chip consensus of 0.9%.

The probability of a 2023 recession is forecasted to be… 43%

Two consecutive quarters of negative GDP growth

About the Kalshi Whisper

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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