Dollars and Jens
Sunday, September 18, 2005
FOMC and prediction markets
There's an FOMC meeting on Tuesday, and the market strongly expects the Fed to tighten again on schedule. While many markets have a good ability to predict events, both by pooling information and by pooling different expertise, there's a third (and even more compelling, in my mind) reason the federal funds futures tend to be good at forecasting fed moves, at least in the short term: because the folks who make the decision want it to. The federal reserve uses the funds market a feedback mechanism; if it seems to expect the board of governors to go all soft, while the fed plans to hike rates, they look for opportunities to sound hawkish, and vice versa. That the market estimate of the funds rate has tacked back toward the likelihood of a hike, and none of the governors has drawn special attention to threats to the economy or talked up that the inflation data are really benign, suggests a tacit confirmation that the market is thinking the same thing they are.

It could also be that there haven't been the opportunities the fed would need for slipping in those statements, or that there isn't even a consensus within the fed as to what to do. I refuse to be surprised if the fed does pause, but that they won't seems the way to bet.

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