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The behavior of federal funds futures prices over the monetary policy cycle

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  • Jeff Moore
  • Richard Austin
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    Abstract

    The federal funds futures market enables market participants to both hedge interest rate risk and speculate on interest rate movements. Prices of federal funds futures also reveal market participants' expectations about changes in Federal Open Market Committee (FOMC) policy. This information allows monetary policymakers to assess the degree to which asset prices already reflect potential policy moves and these prices' likely reaction to policy changes that deviate from market expectations. ; This article examines the relationship between U.S. monetary policy changes and futures market participants' ability to forecast these changes. Previous research has shown the federal funds futures market to be a relatively good forecaster of changes in the fed funds rate on average. But these studies treated futures market data as a single sample and failed to take into account the significant changes in forecast error behavior over different periods of the monetary policy cycle. ; The authors find that futures market forecast error mean and variance differ substantially over various stages of the monetary policy cycle, with overall performance improving considerably in the latter half of the 1990s before deteriorating sharply through 2000 and 2001. The data also reveal both substantial overshooting and undershooting by futures prices around turning points in the path of the funds rate. Finally, the evidence suggests that increased disclosures of information by the FOMC during the past decade have played only a minor role in improving futures market participants' forecasting performance.

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    Bibliographic Info

    Article provided by Federal Reserve Bank of Atlanta in its journal Economic Review.

    Volume (Year): (2002)
    Issue (Month): Q2 ()
    Pages: 45-61

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    Handle: RePEc:fip:fedaer:y:2002:i:q2:p:45-61:n:v.87no.2

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    Related research

    Keywords: Federal funds market (United States) ; Monetary policy;

    References

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    1. Söderström, Ulf, 1999. "Predicting monetary policy using federal funds future prices," Working Paper Series 85, Sveriges Riksbank (Central Bank of Sweden).
    2. Antulio N. Bomfim & Vincent R. Reinhart, 2000. "Making news: financial market effects of Federal Reserve disclosure practices," Finance and Economics Discussion Series 2000-14, Board of Governors of the Federal Reserve System (U.S.).
    3. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
    4. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November.
    5. William Poole & Robert H. Rasche, 2000. "Perfecting the market's knowledge of monetary policy," Working Papers 2000-010, Federal Reserve Bank of St. Louis.
    6. Joe Lange & Brian Sack & William Whitesell, 2001. "Anticipations of monetary policy in financial markets," Finance and Economics Discussion Series 2001-24, Board of Governors of the Federal Reserve System (U.S.).
    7. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
    8. John B. Carlson & Jean M. McIntire & James B. Thomson, 1995. "Federal funds futures as an indicator of future monetary policy: a primer," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 20-30.
    9. John C. Robertson & Daniel L. Thornton, 1997. "Using federal funds futures rates to predict Federal Reserve actions," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 45-53.
    10. Daniel L. Thornton, 1996. "Does the Fed's new policy of immediate disclosure affect the market?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 77-88.
    11. Joel T. Krueger & Kenneth N. Kuttner, 1995. "The Fed funds futures rate as a predictor of Federal Reserve policy," Working Paper Series, Macroeconomic Issues 95-4, Federal Reserve Bank of Chicago.
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    Cited by:
    1. Adrienne Kearney & Raymond Lombra, 2003. "Fed funds futures and the news," Atlantic Economic Journal, International Atlantic Economic Society, vol. 31(4), pages 330-337, December.
    2. J. Benson Durham, 2003. "Estimates of the term premium on near-dated federal funds futures contracts," Finance and Economics Discussion Series 2003-19, Board of Governors of the Federal Reserve System (U.S.).
    3. Kenneth B. Petersen & Vladimir Pozdnyakov, 2008. "Predicting the Fed," Working papers 2008-07, University of Connecticut, Department of Economics.

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