Projecting the Increase in the Fed Funds Rate

July 11, 2014 | Mike Spychalski, CAIA, Vice President

On July 9, the Federal Reserve released the minutes from the June FOMC meeting which indicated that it is planning to continue the taper of its bond buying program at the current pace and expects to end the bond purchases entirely in October. With the Fed’s bond buying program (more formally known as quantitative easing) coming to an end, the next step for the Fed will likely be an increase in the fed funds rate. In order to illustrate the market’s expectations for the timing of the increase in the fed funds rate, this week’s Chart of the Week shows the implied fed funds rate derived from the fed funds futures market. As the chart indicates, the market currently expects the fed funds rate to remain within the current target level of 0.00–0.25% (0–25 basis points) throughout 2014 and expects the first rate hike to occur at the June 2015 meeting. From there, the market is currently pricing in a series of gradual hikes in the second half of 2015 and throughout 2016 and 2017.

It should be noted that while the fed funds futures market has historically been fairly accurate at predicting near term movements in the fed funds rate (i.e., six months and in), it has a fairly poor track record of predicting longer-term movements (i.e., greater than six months out) especially during periods of transition in Fed policy. Nonetheless, it is important to be aware of what the fed funds futures market’s current expectations are, as changes in these expectations have the potential to significantly impact the broad markets.