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Looking to the Futures

Fed Funds Futures Await FOMC Tomorrow, Expecting a Clear Path to Lower Rates

Key Points
  • All Eyes on Federal Reserve Meeting for Hints at Dovish Q3, Q4 Rate Direction 

Monetary policy will be at the forefront this week as the U.S. Federal Reserve, the Bank of Japan, Bank of England, Norway, Brazil, Taiwan, and Indonesia all provide updated observations and intentions.    

The world’s central bankers will be setting monetary policy this week, and hopefully when they wrap up their work on Friday, futures traders will experience a profitable, albeit rare, triple witching + summer solstice combo. Yes it’s true, so if you’re combining your futures trading with some astrological timing strategies, brace yourselves. The solstice will occur Friday at 11:54 a.m. ET, sandwiched in between the expiration of stock index futures, stock options, and stock index options.

But more importantly, the U.S. Federal Reserve’s meeting begins Tuesday, followed by a rate announcement Wednesday at 2:00 p.m ET, and then a press conference.  

The Federal Open Market Committee meets eight times per year to establish a target range for the Federal Funds rate. The CME’s 30-Day Fed Fund Futures are one of several widely used tools which offer leveraged exposure to short-term interest rates. As an investment vehicle, the contracts provide an observable gauge of market expectations about the Fed’s action at future FOMC meetings.

Rate Cut Unlikely at June Meeting

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 Monday afternoon, we observe a 21% chance of a 25 basis-point decrease at tomorrow’s meeting, leaving a 79% chance that rates remain unchanged.

It’s certainly worth noting how the market is positioned for the possibility of a 25 basis-point cut. There are large sums of capital bidding the expiring June Fed Funds Futures above the “no cut” price point, so we can only wonder what these market participants know, or have in mind.

Using the CME FedWatch Tool calculations, we can see where futures trades are positioned, observing the market’s stance on Wednesday’s FOMC decision and how it has changed slightly in the past month. Note the current Fed target rate is 2.25 – 2.5%.    

As we look farther out into the remainder of 2019 and 2020, the Fed Funds Futures market is bracing for repeated rate cuts, taking the assumed Fed Funds target down to around 1.50% and keeping it there for a prolonged period. Assuming we get no rate change Wednesday, the market is trading the remaining 2019 Fed Funds Futures contracts with pricing that implies the Fed will do three 25-basis point rate cuts before year’s end.

Divergence in the Dot Plot vs. Fed Funds Futures

When decision-making members of the Federal Open Market Committee are asked about their vision of future Fed target rates, the responses are plotted (below) and become commonly known as the Dot Plot. Even though the data below is somewhat dated (March 2019) the blue dots spanning out to 2022 reveal higher rate predictions by FOMC policy makers 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.     

Fading Possibilities for Rate Hikes

Things have changed now, but nine months ago the market was expecting several hawkish rate increases that would have hiked the Fed Funds target to 2.75-3.0% by this December. 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 Cut Rates

Challenged with the constant pursuit of manageable inflation and maximum employment, the Fed’s dual mandate currently seems to be on the desired path. Based on observations of past rate cuts, there are several indicators that tend to precede rate cuts including an uptick in unemployment, declining ISM data, tightening financial conditions, and an inverted yield curve. As it stands now, we’ve experienced the inverted yield curve, and the ISM has been barely clinging to readings above 50 (ISM < 50 reveals contracting activity).

Fed Funds Futures

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. It shouldn’t come as a big surprise that as rates emerged from a prolonged period near zero, open interest in the CME’s entire lineup of interest rate futures has been trending up.

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 98.25, the implied fed funds target rate would be 1.75%. Every full point of movement in the futures price would equate to a $4,167 profit or loss. Margin requirements are currently set at $258 for the June 2019 contract, $658 for December 2019, and $916 for the December 2020 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

EIA Crude Oil Inventories                                    06/19/2019 10:30 a.m. ET

FOMC Rate Decision                                          06/19/2019 2:00 p.m. ET

June ISM Data                                                     07/01/2019 10:00 a.m. ET




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