Are we there yet?

Almost, but not quite, sayeth the fed funds futures.

Fed funds futures prices have done a pretty good job at predicting what the Fed would do over the last four years. The dark blue line in the graph below shows the actual average effective fed funds rate for each month since January, 2003. The magenta lines represent the forecasts formed at the beginning of January and beginning of July for each year, looking 1 to 6 months ahead, based on the values of fed funds futures contracts for horizons of 1 to 6 months ahead. Historical values for these prices are available from Spot Market Place, and the most recent values for July 13 (used to draw the final magenta segment) are reported each day by the Chicago Board of Trade.




fed_funds_futures_03_06.gif


When the funds rate held steady during 2003 and the first half of 2004, that’s exactly what the market anticipated. The futures prices also perfectly anticipated the timing and magnitude of the rise in interest rates during the second half of 2004 and first half of 2005.

The market was a little surprised that the Fed continued with the tightening as far as it did during the past year. Looking forward from either July 1, 2005 or January 3, 2006, the market was expecting one less hike in the funds rate than actually materialized over either 6-month period.

The near-term yield curve implied by the fed funds futures contracts has flattened even further since January. The market now seems to be betting on one more rate hike out of the remaining FOMC meetings for this year, but no more.

The graph below from the Federal Reserve Bank of Cleveland uses the prices of options (rather than the futures contracts employed above) to try to attach a probability to each possible outcome of the FOMC meeting coming up August 8. There’s still a lot of uncertainty about the outcome of that particular meeting, but many traders seem to view an August rate hike to 5.5% as a little more likely than not.

And hopefully, that will be it.




fed_funds_probs_july_06.gif



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One thought on “Are we there yet?

  1. Anonymous

    Are we there yet?

    “The market now seems to be betting on one more rate hike out of the remaining FOMC meetings for this year, but no more.”

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