Thursday, January 15, 2015

Federal Funds Rate Hike in October?

Predictions based on futures market data suggest a more than 50% chance of a federal funds rate hike in October, much later than other sources have suggested. Though the most recent FOMC minutes suggest the Fed will begin to raise rates as early as April and a recent poll suggests June as a likely candidate (based on stronger employment data in December), the federal funds interest rate futures contracts suggest the rate hike won't begin until October.

Specifically, the CME Group FedWatch uses data from federal funds rate futures contract prices to calculate the probability of a rate hike and the implied probability of various interest rate targets for a given month. As of the time of this writing, the October 2015 contract is the earliest month with a probability of a rate hike greater than 50%. This contract doesn't suggest much of a hike: the implied probabilities of a 0%, 0.25%, and 0.5% federal funds rate in October are 14.1%, 35.4%, and 33%, respectively.

The highest federal funds rate target suggested by the data in October is 1.25% with an implied probability of a measly 0.3%. To put that rate in perspective, the last time the federal funds rate was greater than 1.25% was September 2008. We've been in a very low interest rate environment for a long time. Looking beyond October, the December contract price suggests a 61% probability of a rate hike and the January price suggests a 76% chance.

It's certainly possible that the Fed could choose to raise rates at any time. I've already discussed what I think the return to "normal" interest rates will do to agricultural asset markets. Nicole Gelinas puts it very well in an article discussing the recent history and possible future of Federal Reserve policy: "Raising rates, Blinder cautions, 'needs to be done deftly.' Indeed. But if higher interest rates only expose the problems that low interest rates have hidden, even deftness won’t suffice."

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