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-0399.000
99.020
99.050
99.065
99.075July 18, 2003
August 15, 2003
September 19, 2003
October 17, 2003
November 21, 2003August 12, 2003
September 16, 2003
October 28, 2003100 – 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 Change1.0% – 0.98% = 0.02
0.02 ÷ 0.25 =
0.08Based 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.