Reading the Fed “tea leaves”

Authored by Jeff Messer and Mike Geraty

A lot of your Aunt Rita’s advice about the future – for what it’s worth – comes from the bottom of her teacup. And while reading patterns in tea leaves is one way to divine the future, using Federal Funds Futures Contracts (FFFC) to predict future rate hikes and cuts is much more reliable.

In 2019, the market anticipated lower rates and the Fed delivered. Interest rates are on hold for now and through most of 2020. How do we know? 

•  Short-term interest rate futures derive their value from the interest rate at maturity. A value of $97 implies a rate of 3.00% (100-97).   
•  The FFFC expiring Feb. 28, 2020 trades at $98.415. The implied Fed Funds rate for February is 1.585% (100-98.415). The FFFC expiring May 31, 2020 trades at $98.47. The implied rate for May is 1.53% (100-98.47). Both are within the Fed’s current target of 1.50-1.75%. 
•  The FFFC expiring September 30, 2020 trades at $98.605. The implied rate for September is 1.395%, which is below target. Will the Fed ease at their Sept. 16, 2020 meeting? 

This is where the CME Group’s FedWatch Tool comes in handy. It considers whether there is a Federal Open Market Committee (FOMC) meeting during the month, the meeting date, the number of days in the month and whether the Fed moves in 25, 50 or 75 basis point increments. Probabilities are calculated from these inputs.    

Currently, there is a 62.3% probability of an ease.                      

For more information on this topic, or to learn how Baker Tilly Investment Services specialists can help, contact our team.