Economists and pundits like to pontificate on if and when the Federal Reserve will raise ultra-low short-term interest rates. But there’s an easier way to get a reading on Fed moves, and it’s right under your nose.
Editor's note: We've dusted off this article that originally ran on April 21, 2015. It's worth a rerun because its usefulness for help tracking the Federal Reserve's potentially too-close-to-call interest rate decision is just as important now as it was then. You can find Fed funds futures pricing on the CME Group website. The Fed has two policy meetings left this year: one on October 28-29 and another December 16-17.
One of the biggest questions in the financial markets this year is whether the Federal Reserve will raise short-term interest rates from near zero. And if so, when?
The Fed has a tool for tinkering with short-term rates. It’s called the Federal funds rate, and it’s the interest rate that commercial and retail banks charge other banks to borrow their reserves held at the Fed, our central bank. That makes this little number an important benchmark for financial markets, and it’s closely watched by investors and economists. In fact, they spend a lot of time and energy trying to decipher “Fedspeak” for a clue about what’s next for the Fed funds rate. There’s no shortage of opinions from pundits about the Fed’s next move. And you know what they say about opinions …
For many market participants, there’s a better way to try to predict what the Fed may do with its funds rate: analyze the 30-day Fed funds futures (/ZQ). The /ZQ reflects the opinions of real traders with real money at risk. After all, how many economists put money behind their predictions?
FIGURE 1: PRICING IN FED POLICY.
Fed funds futures change constantly as traders buy and sell contracts based on their expectations for monetary policy moves at the Federal Reserve. Financial markets generally expect higher rates beginning later this year. Source: CME Group. For illustrative purposes only. Past performance does not guarantee future results.
There’s a simple way to read the Fed funds futures and determine what traders are expecting and when they expect it. The formula: start with a basis of 100 and subtract the last price of the contract month you’re analyzing. For example, look at the last price of the SEP 2015 contract of 99.745 in Figure 1. Subtract it from 100 and you get 0.255. That means traders expect the federal funds rate to be at 0.25% in September. Now look at the DEC 2015 contract and repeat the calculation: 100 – 99.585 = 0.415, or just over 0.41%. Traders expect the federal funds rate to rise by December.
The data in Figure 1 was captured after the March 18 Fed meeting. You can see from the green running up and down the “change” column that market expectations shifted. At that meeting, the Fed indicated it would raise its funds target at a slower pace than was previously expected. This caused Fed funds futures to rally, reducing the probability of a rate hike and pushing any eventual hike well into the future.
This brings up an important point: the Fed funds futures change all the time as traders buy and sell contracts based on their expectations for future rate hikes. That means with each new drip of fresh economic data, including the closely watched non-farm payrolls or inflation reports, the Fed funds futures could change, and so too could expectations for a hike in the Fed funds rate.
The next time a Fed meeting rolls around or an economist is jawing on CNBC about rate hikes, check the Fed funds futures. Do they track? This single pricing screen can be one of the most reliable sources of data for expectations for Fed policy. Remember, it’s expectations for interest rates that help set demand for interest rates, driving their value up and down. That makes the Fed funds markets potentially valuable when making investing decisions based on the future of interest rates.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Investools, Inc. and TD Ameritrade, Inc. are separate but affiliated companies that are not responsible for each other’s services or policies.
Investools® does not provide financial advice and is not in the business of transacting trades.
CME Group and TD Ameritrade, Inc. are separate and unaffiliated and not responsible for each other's services and policies.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 TD Ameritrade.