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Predicting monetary policy using federal funds futures prices

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  • Söderström, Ulf

    ()
    (Research Department, Sveriges Riksbank)

Abstract

In theory, prices of current-month federal funds futures contracts should reflect market expectations of near-term movements in the Federal Reserve's target level for the federal funds rate. However, empirical results show that such measures of market expectations are too noisy to predict day-to-day changes in the funds rate target; partly due to time aggregation problems, partly because they are affected by funds rate movements not directly related to monetary policy considerations. In particular, the futures market shows a large amount of systematic variation across months and trading days, variation that needs to be taken into account when predicting policy moves or extracting policy expectations. For the period from January 1994 to February 1998, the extracted expectations perform fairly well in predicting the target level that will prevail after the next meeting of the Federal Open Market Committee, expecially when adjusting for market regularities.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 307.

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Length: 32 pages
Date of creation: 08 Mar 1999
Date of revision:
Publication status: Published in Journal of Futures Markets, 2001, pages 377-391.
Handle: RePEc:hhs:hastef:0307

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Keywords: Market expectations of monetary policy; The Federal Reserve; The Federal Open Market Committee;

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References

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  1. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
  2. Paul Soderlind & Lars E. O. Svensson, 1997. "New Techniques to Extract Market Expectations from Financial Instruments," NBER Working Papers 5877, National Bureau of Economic Research, Inc.
  3. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  4. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  5. Charles L. Evans & Kenneth N. Kuttner, 1998. "Can VAR's describe monetary policy?," Working Paper Series WP-98-19, Federal Reserve Bank of Chicago.
  6. 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.
  7. Marvin Goodfriend & William Whelpley, 1998. "Federal funds," Monograph, Federal Reserve Bank of Richmond, number 1998f.
  8. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  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. Allen, Linda & Saunders, Anthony, 1992. "Bank window dressing: Theory and evidence," Journal of Banking & Finance, Elsevier, vol. 16(3), pages 585-623, June.
  11. V. Vance Roley & Gordon H. Sellon, Jr., 1996. "The response of the term structure of interest rates to federal funds rate target changes," Research Working Paper 96-08, Federal Reserve Bank of Kansas City.
  12. 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.
  13. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  14. 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.
  15. Spindt, Paul A. & Hoffmeister, J. Ronald, 1988. "The Micromechanics of the Federal Funds Market: Implications for Day-of-the-Week Effects in Funds Rate Variability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(04), pages 401-416, December.
  16. Saunders, Anthony & Urich, Thomas, 1988. "The effects of shifts in monetary policy and reserve accounting regimes on bank reserve management behavior in the federal funds market," Journal of Banking & Finance, Elsevier, vol. 12(4), pages 523-535, December.
  17. Michael R. Pakko & David C. Wheelock, 1996. "Monetary policy and financial market expectations: what did they know and when did they know it?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 19-32.
  18. Ho, Thomas S Y & Saunders, Anthony, 1985. " A Micro Model of the Federal Funds Market," Journal of Finance, American Finance Association, vol. 40(3), pages 977-88, July.
  19. Griffiths, Mark D. & Winters, Drew B., 1995. "Day-of-the-week effects in federal funds rates: Further empirical findings," Journal of Banking & Finance, Elsevier, vol. 19(7), pages 1265-1284, October.
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Citations

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Cited by:
  1. Martin Hlusek, 2002. "Estimating Market Probabilities of Future Interest Rate Changes," Working Papers 2002/02, Czech National Bank, Research Department.
  2. Kjellberg, David, 2006. "Measuring Expectations," Working Paper Series 2006:9, Uppsala University, Department of Economics.
  3. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2006. "Market-based measures of monetary policy expectations," Working Paper Series 2006-04, Federal Reserve Bank of San Francisco.
  4. Andrea Monticini & Giacomo Vaciago, 2005. "Are Europe's Interest Rates led by FED Announcements?," Macroeconomics 0507022, EconWPA.
  5. Raymond E. Owens & Roy H. Webb, 2001. "Using the federal funds futures market to predict monetary policy actions," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 69-77.
  6. Jeff Moore & Richard Austin, 2002. "The behavior of federal funds futures prices over the monetary policy cycle," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 45-61.

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