What are Fed Funds Futures contracts? Can they be used to predict future Fed moves?

The Fed Funds futures are derivative contracts written with the Federal Open Market Committee’s target overnight bank lending rate as the underlying asset. Accordingly, contract expiration months are based on scheduled Fed Meetings, as opposed to the typical quarterly expiration in financial futures. Not unlike any other futures contract, Fed Funds futures contracts can be bought or sold in any order as a speculative tool to bet on, or hedge, expectations of changes in the Federal Reserve’s target interest rate.

In a bare bones example, if you think the FOMC will be increasing interest rates you would sell the Fed Funds futures; if you believed the Fed will lower rates you would be a buyer. This might sound counterintuitive, but in reality the price of an interest rate product moves inversely to rates. Thus, if interest rates rise bonds, notes, and even Fed Funds futures contracts fall; and vice, versa.

The Fed Funds futures contracts are quoted similar to a discount bond. In essence, they are valued relative to 100.00 minus basis points, where 100.00 is equal to an interest rate of zero. For example, at the time of this writing the January 2015 Fed Funds futures contract was trading at 99.9150. This implies that the market believes, in that moment, that the Fed Funds interest rate will be 0.085% at the time this futures contract expires. This is figured by subtracting 99.9150 from 100.00.

Many speculators look to the Fed Funds futures market for answers as to when the Fed might be taking action next. While most traders in Fed Funds futures are high sophisticated and are likely buying and selling these futures contracts after diligent consideration, it is important to understand that they might be wrong. Simply put, the Fed Funds futures market gives us a glimpse into the expectations of other traders but it does not tell us with certainty what the future will bring.

 

Read more about Fed Funds Futures contracts in the December 2014 issue of Stocks & Commodities Magazine.

Futures and Options Trading Booksby Carley Garner

What People are Saying about Our Commodity Trading Books

Choosing a Futures Broker and Brokerage Service

Full-Service or Online Trading?

The decision to trade online or through a full-service commodity broker will undoubtedly make a large impact on your bottom line.

Learn More

A Fair Commission Rate vs. Low Commission

To look at commission rates objectively, we must understand the background of the futures industry and how brokerages accept risk for fees.

Learn More

Choosing a Commodity Brokerage Firm

Deciding on a commodity brokerage firm is a significant decision and shouldn’t be taken lightly. Not all traders and brokers are compatible.

Learn More

Choosing a Futures and Options Broker

Most traders in search of a futures broker are concerned primarily with trading platforms, commission, and quality guidance.

Learn More

The Truth about Futures Commission

The goal of futures trading should be to MAKE money, not SAVE it! Discount commodity brokers cut corners that cost their clients time & money.

Learn More

Commodities via Futures or ETFs?

A key difference to trading commodity futures over ETFs is leverage, but there is more to discuss, such as taxes, market hours, and efficiency.

Learn More