Download the Schwab app from iTunes®Get the AppClose

Looking to the Futures

Fed Funds Futures Volume Grows Amid Rate Uncertainty

Key Points
  • June FOMC Meeting Could Reveal Next Leg in Rate Trends

Federal Reserve Governor Lael Brainard spoke yesterday to the National Press Club in Washington, sharing observations on the economic landscape. One key point she made signaled the Fed’s possible willingness to withstand inflation data in excess of 2% without raising interest rates, acknowledging that a higher inflation target would have benefits but also risks.

At the same time, Minneapolis Fed President Neel Kashkari was discussing interest rates, monetary policy, and the economy at the Santa Barbara County Economic Summit. Leaning to similar inferences, he shared the idea that the Fed could wait for faster wage growth before raising rates.

As data emerges over time, and Fedspeak provides morsels of guidance, many investors and economists will develop a guess and share a comment about their interest rate forecasts. But true skin in the game is keenly observable in the Fed Funds Futures market where capital is put at risk, lending true validity to the opinions of market participants. In addition to their value as a predictive tool, Fed Funds Futures also provide a means of hedging and gaining exposure to short-term interest rate risks.

Fed Funds Futures

We experienced an extended period when the Fed Funds target rate was 0% - .25% and there wasn’t much to see or do with respect to short term interest rates. Now the landscape is changing. 

Launched 31 years ago at the Chicago Board of Trade, Fed Funds Futures have seen increased volume since the Fed started raising the target rate in December 2015. Average daily volume grew to 191,148 in 2017. With four FOMC rate hikes in 2018, average daily volume expanded to 259,273, a 36% year-over-year increase. In the first quarter of 2019 ADV increased to 274,000. Open interest has grown as well.

The Fed’s Direction

The retreat in stock prices last fall, along with concerns about slowing global growth and trade disputes has swayed the Fed to tap the breaks on their initiative to restore interest rates to higher, “normalized” levels.   

Using Fed Funds Futures as a lens, we can observe (below) how the market is anticipating upcoming Federal Open Market Committee rate decisions. As of Thursday afternoon, we observe roughly a 13% chance of a 25 basis point decrease at the June 19, 2019 meeting, leaving an 87% chance that rates remain unchanged. Other outcomes from next month’s announcement, such as a 50 basis point decrease, or any rate increase, aren’t in the realm of possible outcomes. Using the CME Group FedWatch calculations, we can see where large sums of capital are positioned, observing the market’s stance on next month’s FOMC decision as well as the landscape for December 2019:   

 

In review, the current market-driven setup implies no rate change at the June 2019 FOMC announcement, however a slim chance for a 25 basis point cut exists. As we look deeper into 2019, the money is pointing to some degree of rate cuts, likely 25 basis points, however there are possibilities for either 50 - or 75 basis point rate cuts by year’s end.

Divergence in the Dot Plot vs. Fed Funds Futures

When the Federal Open Market Committee is asked about their vision of future Fed target rates, the responses are plotted (below) and become commonly known as the Dot Plot. The blue dots spanning out to 2022 reveal higher rate predictions when compared to the market-driven red dots that represent where the Fed Funds Futures see future rates. Maybe the futures market has it pegged accurately, or maybe it’s better predicted by the FOMC dots, but it’s also possible that everyone is wrong.      

Case for Additional Rate Hikes

The Fed would like to get rates to moderately higher levels if it can be done without negative side effects. Higher rates would provide the Fed with ammunition to deal with possible future economic slowdowns.

Reasons to Pause or Drop Rates

Challenged with the constant pursuit of manageable inflation and maximum employment, the Fed’s dual mandate currently seems to be cruising along pretty well, so risking the delicate balance with too many rate increases could be a mistake. The term “balanced risks” refers to the Fed’s observation that the current rate environment may be appropriate to maintain for a while as the economy forges ahead and more data becomes available.  

Fed Funds Futures Contract Specifications

Fed Funds Futures Contracts are listed monthly, and are priced at 100 minus the expected fed funds rate. So if the Dec. 2019 contract is trading at 97.865, the implied fed funds target rate would be 2.135%. Every full point of movement in the futures price would equate to a $4,167 profit or loss. Margin requirements are currently set at $176 for the May 2019 contract, and $440 for the December 2019 contract.

The contracts are cash settled at expiration with a mark-to-market process against the average daily Reference Interest Rate during delivery month. Final settlement occurs on the 1st business day following Last Trading Day.

Looking Ahead

Leading Indicators                                            05/17/2018 10:00 a.m. ET

U. of Michigan Consumer Sentiment               05/17/2018 10:00 a.m. ET

Powell Speech at Atlanta Fed Conference      05/20/2019 7:00 p.m. ET

FOMC Rate Decision                                       06/19/2018 2:00 p.m. ET

 

What You Can Do Next

  • Read more futures content 
  • Register for an upcoming no-cost webinar to dive further into trading topics that interest you.
  • Open a Schwab Trading Services account to access our best tools and services for traders.
  • Read more timely content from our other Schwab trading specialists 

Schwab has tools to help you mentally prepare for trading

Learn more >

Talk trading with a Schwab specialist anytime.
 
Call 888-245-6864
M-F, 8:30am - 9:00pm EST

Get 500 Commission-Free Online Equity and Options Trades for Two Years

Learn More >

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against trading losses.

Futures trading offered and positions held through Charles Schwab Futures, Inc., a separate but affiliated company of Charles Schwab & Co., Inc. Both are subsidiaries of The Charles Schwab Corporation. Futures trading involves substantial risk and is not suitable for all investors. Please read Risk Disclosure Statement for Futures and Options.

Virtual Currency Derivatives trading involves unique and potentially significant risks.  Please read  NFA Investor Advisory – Futures on Virtual Currencies Including Bitcoin and CFTC Customer Advisory: Understand the Risk of Virtual Currency Trading.

Charles Schwab & Co., Inc. (“Schwab”) (Member SIPC) and Charles Schwab Futures, Inc. (“Schwab Futures”) are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. Nothing here is an offer or solicitation of securities, products, or services by Schwab or Charles Schwab Futures in any jurisdiction where their offer or sale is not qualified or exempt from registration.

Charles Schwab & Co., Inc., 211 Main Street, San Francisco, CA 94105

©2018 Charles Schwab & Co., Inc. All rights reserved. Member SIPC.

(0519-98GN)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.