Fed meetings are highly anticipated events, and the financial media loves to stir up excitement ahead of each meeting. How will monetary policy change? Who will win and who will lose? This is where the Fed Funds futures come into play.
The Fed Funds futures market can help you anticipate where policy may be headed. It is highly liquid and is well-traded on a regular basis. But it does have its limitations.
What to know about the Fed Funds futures
The futures are just that – predictions
The futures market does not guarantee what the Fed’s monetary policy will be. It only uses collective market insights to predict an outcome.
In fact, the only reason it exist is that someone at some point wanted to create a prediction tool and make a market. Does the Fed use the futures to craft policy? Not really. Of course, they are aware of what the market wants to happen. That doesn’t mean they will fulfill that wish.
You may recall that in late 2023, futures were expecting up to seven rate cuts in 2024. The Federal Open Market Committee only delivered four. That is a big difference, and many traders were squeezed by it.
It can move dramatically
If Fed policy looks like it is at a turning point, the futures market will move up (or down) dramatically to get ahead of that pivot. This can impact the markets overall and thus your portfolio.
It can also move quickly based on data releases like the jobs report, inflation reports, consumer sentiment, etc. In other words, pinpoint accuracy is not the hallmark of this market.
How to trade this market
The futures are pretty unreliable over the long-term due to its dramatic moves. However, if you are looking for a short-term trading vehicle where you can get in and out quickly without much damage, the Fed Funds futures is a great option.
