Fed fund futures settle to the average Fed Fund effective rate over the calendar month. Since the December hike, the next contracts closed out the month as follows: January 2016 at 99.6575, Feb 2016 at 99.625 and March 2016 99.6375. So the average Fed effective rate over the three months has been approximately 36 bps (price of 99.640).
If the Fed were to hike again, then we would expect FF to trade to around 61-62 bps, or, splitting the difference, a price of 99.385. There has been a reasonable amount of speculation about when the next hike might come. Several Fed officials have indicated that the meeting in late April is “live’, but the FF futures consider it “dead” as reflected in the May FF contract price of 99.630.
The actual FOMC dates are April 27, June 15, July 27 and Sept 21. The October FF contract thus encompasses the odds for 4 meetings. Well, April is dead, but the next three anyway. Some people believe the Fed won’t want to hike right in front of the June 23 Brexit vote. Greece has a contentious payment due to the IMF July 13.
So let’s consider the emotional roller coaster the market has had this year by looking at the April’16/October ’16 FF spread. If we were absolutely certain of ONE 25 bp hike at just one of these three meetings, then the spread would be at least 25 bps. This spread started the year at 28 bps, then sank all the way to zero by mid-Feb when oil made new lows and stocks were sagging. By March 15, the spread was back up to 23.5 bps. On March 16, the dovish FOMC meeting and conference took place, and the spread closed at just 17. On March 29, Yellen gave another dovish outlook speech, which now leaves the spread at just 12.25 bps (as of April 5). At this point, we conclude that the odds for just one 25 bp hike at any time over the next three meetings are only about 50/50.
I continue to read that Goldman is expecting three hikes this year. If the market agreed, then this spread would be at least 25 bps, and likely something more like 40 bps. Obviously, the market does not agree. I am not calling the current level of the spread either right or wrong, just saying that 1) it’s been somewhat of an emotional roller coaster year across many markets, and 2) this spread has never shown certainty of any more than one hike over the June, July and Sept meetings.
Alex Manzara
