 Ask
Dr. Econ
March 2003
Where can I find forecast information on interest rates over for the
next two years?
NOTE: On January 25, 2012, as part of the Fed's policy of increasing transparency and improving communications, the Federal Open Market Committee (FOMC) began releasing Projections Materials that include FOMC Participants assessments of the appropriate timing of monetary policy firming (measured by the target federal funds rate at year-end) over a three year time horizon.
Interest Rate Forecasts Are Not Available from the Fed
The Federal Reserve's monetary policy-making body, the Federal Open
Market Committee (FOMC), typically meets eight times each year to evaluate
economic and financial market conditions and make a decision on whether
to raise, lower, or keep the target federal funds interest rate unchanged.
However, the FOMC does not issue interest rate forecasts. The federal
funds rate plays an important role in influencing other interest rates,
especially short term interest rates. An interest rate forecast by the
Fed would, therefore, essentially be revealing an "inside" opinion
about the FOMC's next decision.
But, Information about Future Interest Rates is Available…If
You Know Where to Look
No need to despair though, the economic and financial information
available to the general public is sufficient to formulate a rather accurate,
short-term prediction of interest rates. Of course, the vast amount of
information that is available on the Internet alone, and the speed in
which people can access it, contributes to the availability of such forecasts.
In 1994, the Federal Reserve System and the FOMC made an important policy
change that directly led to the availability of accurate, timely interest
rate forecasts using publicly available, market information. Before that
year, the FOMC used an operating procedure that targeted borrowed reserves
and resulted in a federal funds rate that was difficult for the general
public to determine. The FOMC didn't explicitly reveal a target fed funds
rate or even give a sense of near-term policy expectations. In 1994, the
FOMC moved to the current process of revealing the target fed funds rate
shortly after each FOMC meeting, along with a statement
of the committee's opinion on the direction of the economy (see FOMC schedules
for more information). This information is available on the Federal Reserve
Board's Web site, and released
to the media at 2:15 PM EST on the day of the FOMC's decision.
The Federal Funds Futures Market
The Chicago Board of Trade (CBOT) trades 30-day Fed Funds futures
. The timely information that's available about the price of these financial
instruments offers useful, unbiased information about the future movement
of the fed funds rate. In other words, the price of a futures contract
is the market's collective opinion about the future actions of the FOMC
with regard to the fed funds rate. To learn more about how you can use
market data to predict the FOMC's next move, just follow these five simple
steps.
- Find the current prices of fed funds futures. The easiest way
to do this is to find the information online. Two good sources are the
Wall
Street Journal's Free Online Resources or the Chicago
Board of Trade Web site. There is a fed funds futures contract for
each month.
- Find the contract price that is effective on the third Friday of
the month. Find the effective date by simply looking at a calendar
and recording the date of the third Friday of each month.
- Find the fed funds futures contract that expires after the FOMC
meeting. This is the one that will give an indication of anticipated
federal funds rate changes. Find the FOMC meeting dates by checking
the FOMC meeting
calendar online. (Remember that some months do not have a scheduled
FOMC meeting; it's OK to just leave those blank.)
- Calculate the fed funds rate that is implied by the price of the
futures contract by subtracting the futures price from 100.
| |
Step 1 |
Step 2 |
Step 3 |
Step 4 |
| Month |
Futures
Price |
Effective
Date |
FOMC
Meeting |
Implied
Rate |
|
Jul-03
Aug-03
Sep-03
Oct-03
Nov-03
|
99.000
99.020
99.050
99.065
99.075
|
July 18, 2003
August 15, 2003
September 19, 2003
October 17, 2003
November 21, 2003
|
August 12, 2003
September 16, 2003
October 28, 2003
|
100 - 99 = 1%
100 - 99.020 = 0.98%
100 - 99.050 = 0.95%
100 - 99.065 = 0.935%
100 - 99.075 = 0.925%
|
|
- Calculate the chance of a 25 basis point change in the fed funds
rate, according to the market. Subtract to find the difference between
the current fed funds target rate. Then divide the difference by 0.25
(for 25 basis points).
|
General
Formula
(based on a specific futures contract
date)
|
Calculations based on
the
August 15, 2003
futures contract
|
|
(Target Fed Funds) - (Implied
Rate) =Rate Spread
(Rate Spread) ÷ (25 Basis
Point Charge) =
% Chance of a 25 Basis Point Change
|
1.0% - 0.98% = 0.02
0.02 ÷ 0.25 =
0.08
Based on market information
about the August 15, 2003 futures contract, there is an 8% chance
that the FOMC will lower rates by 25 basis points at the next
meeting.
|
How Accurate are Fed Funds Futures Markets in Predicting FOMC Actions?
Much of the information upon which the FOMC bases its policy decision
(employment, unemployment, income, consumer spending, and productivity)
is public information and is readily available to buyers and sellers of
fed funds contracts. As new information is available, market participants
may alter their view of what action the FOMC will take at the next meeting
and change the price at which they are willing to buy or sell a fed funds
futures contract. At the same time, FOMC members and economists at the
Fed analyze the same economic data and adjust their perceptions of economic
conditions.
William Poole, the current president of the Federal Reserve Bank of Saint
Louis, delivered a speech on this subject in late 2000. In the charts
that accompanied the speech, he demonstrated how the fed funds futures
closely tracked the actual fed funds target rate. He also noted how major
economic reports, such as new employment information, are reflected in
the market's opinion of the FOMC's next decision. For more information,
the entire speech is available online at: http://www.stlouisfed.org/news/speeches/2000/11_30_00.html.
Additional Resources
"Anticipating Fed Action." Chicago
Board of Trade.
http://www.cbot.com/cbot/docs/36784.pdf.
Owens, Raymond E. and Roy H. Webb. "Using the
Federal Funds Futures Market to Predict Monetary Policy Actions. Economic
Quarterly. Federal Reserve Bank of Richmond. Spring 2001.
http://www.rich.frb.org/pubs/eq/pdfs/spring2001/owens.pdf.
Poole, William. "How Well Do the Markets Understand
Fed Policy?" Federal Reserve Bank of Saint Louis. Speech - Center
for Financial Studies. Frankfurt, Germany. 30 Nov 2002.
http://www.stlouisfed.org/news/speeches/2000/11_30_00.html.
|
