Reading The Fed's Mind

Futures markets do a good job of predicting what the Federal Reserve will do--when the forecast is clear. But they may have trouble calling the turning points in monetary policy, say John B. Carlson and Jean M. McIntire, writing in the Federal Reserve Bank of Cleveland's Economic Commentary.

Trading in futures on the federal funds rate--the interest rate used by the Fed as a policy lever--gives a look at policy moves the markets expect over the next six months. In January, 1994, before the Fed began a series of rate hikes, futures prices predicted a modest half-point rise. The Fed surprised traders, boosting the rate by 1.25 percentage points by midyear. Thereafter, forecasts held up for a while--until December, 1994, when futures prices predicted a continued stream of rate hikes, which the Fed didn't deliver. More recently, though, futures traders got it right: They were predicting falling rates even before the Fed cut rates on July 6.

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