We’ve talked a lot about rising interest rates this year…
Out-of-control inflation is a dominant narrative these days. And of course, so is the Federal Reserve’s attempt to tackle the problem. Just about everyone has an opinion on it…
In fact, just last week, I explained that figuring out the Fed’s plan for its future meetings is the “right sign” for investors right now. The topic is inescapable – and critical.
But did you know that institutional-level traders place bets on the Fed? Even better, we can see the summary of these bets. And that can help us figure out what to expect.
So today, let’s talk about the tool Wall Street uses to bet on the Fed. And more specifically, we’ll look at exactly what these power players currently expect to happen next…
First, we need to define a few simple terms…
The first is the “federal funds rate.” The Fed sets this rate. It’s simply the “overnight” rate at which banks borrow and lend their excess reserves to each other in the short term.
All other interest rates are based on this one number. It determines what regular folks like us pay when we borrow money from the bank. It dictates how much interest we get in our savings accounts. And it does the same things for businesses as well.
So even a small tweak to that one number can swing the economy in a big way.
And Wall Street can actively bet on what changes the Fed will make to that number. That leads us to the second term we need to define – “futures contract.”
A futures contract is exactly what it sounds like. It’s a financial agreement to buy or sell a specific item on a specific day in the future. Banks and high-level expert traders use futures contracts to hedge against market movements or to speculate.
A “fed funds futures contract” is the combination of those first two terms. Banks and market experts enter into these contracts in order to speculate or hedge about what the Fed will do with interest rates at a designated point in the future.
Importantly, we can measure how many investors are betting each way at a given time. And we can use that number to figure out the probability of specific rate hikes.
In other words, we can see what Wall Street predicts will happen next at the Fed.
I’m not saying the experts are right every time. We are talking odds after all. But this data is still extremely valuable…
It gives individual investors like us access to information that we didn’t previously know. That’s critical because the big institutions use this data to make their investment decisions.
And fortunately, this data is available to investors like us in CME Group’s FedWatch Tool.
The methodology used in the FedWatch tool can get a little in the weeds. You just need to know that it allows us to see in real time what Wall Street traders expect to happen.
Today, Wall Street traders are virtually certain that the Fed will act again next month…
The FedWatch tool points to a roughly 55% chance that the Fed will boost the federal funds rate by 50 basis points (“bps”) in September. And it shows a 45% chance of a 75-bps hike.
In other words, these experts believe there’s a 100% chance of at least a 50-bps hike in September.
Looking even further out, the FedWatch tool indicates a roughly 63% likelihood that the federal funds rate will be at least 3.5% in December. That’s 100 to 125 bps higher than the current range of 2.25% to 2.5%.
In short, Wall Street expects the Fed to continue raising rates in the months ahead. And as I’ve explained before, that approach will only hurt investors like you and me.
The Fed is on track to strangle the economy long past the decline of inflation. And that means the possibility of a prolonged recession is very real.
But until we know for sure, we’re keeping an eye on how the experts place their bets. And right now, they’re betting on higher rates.
Prepare accordingly.
Good investing,
Karina Kovalcik
