Future prices as risk-adjusted forecasts of monetary policy

Many researchers have used federal funds futures rates as measures of financial markets? expectations of future monetary policy. However, to the extent that federal funds futures reflect risk premia, these measures require some adjustment for risk premia. In this paper, we document that excess returns on federal funds futures have been positive on average. We also document that expected excess returns are strongly countercyclical. In particular, excess returns are surprisingly predictable by employment growth and other business-cycle indicators such as Treasury yields and corporate bond spreads. Excess returns on eurodollar futures display similar patterns. We document that simply ignoring these risk premia has important consequences for the future expected path of monetary policy. We also investigate whether risk premia matter for conventional measures of monetary policy surprises.