Dollars and Jens

Wednesday, June 09, 2004

implied fed funds rates

Often I see something like

federal funds futures are currently pricing in 100% probability of a 25 basis point hike at the June 30 meeting and a 19% probability of a 50 basis point hikeand it irritates me a bit. There is no exchange-traded option on these futures — or in any case, results of my attempts to get prices for said options lead me to believe this — so these probabilities are based on the future market's implied 1.2975% fed funds average rate for July.

Now, the interpretation is probably close to correct in this case, and my irritation is mostly irrational. If I were to question the interpretation, I'd suppose some of the traders imagine a somewhat lower probability of a 50 bp hike at the meeting, with some probability of an inter-meeting hike at some point during July. Me, I wouldn't mind seeing a target set at 1.3%; there's no statutory requirement that it be a multiple of 25bp.

More than that, though, I'd like to see prices on the options for the November future. 2.1%, what they're guessing now, is interesting; I'd like to see how that breaks down in terms of probabilities. I'm 100% sure that's not a 60% chance of a 2.0% rate and a 40% chance of 2.25%.

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