Wed 29 Oct 2008
The Federal Open Market Committee, which began its meeting at 2 p.m. today, will announce its interest-rate decision at 2:15 p.m, or just about 25 minutes from now, New York time. According to Bloomberg News, 43 out of 69 economists surveyed forecast a half- point reduction from the current 1.5 percent rate, 18 economists expect a quarter-point cut, and seven predict no change. However, futures trading suggests a nearly 40% chance that Fed policy makers will cut the target by three-quarters of a percentage point, to 0.75 percent. By contrast, only one of the 69 economists in the Bloomberg survey foresees that outcome. Here are all the implied probabilities from the futures market, according to the Cleveland Fed:
This is an odd discrepancy between economists’ forecast and market forecasts. Historically, Fed Funds futures have been a very good predictor of rate cuts, but that seems to no longer be the case, according to (Williams professor) Ken Kuttner:
Bernanke, 54, extolled the value of the futures when he was a Fed governor in 2004 in research showing the stock market’s reaction to FOMC decisions. The paper cited futures data in measuring how much policy changes between 1989 and 2002 surprised investors.
Federal funds futures are a “convenient, market-based way to identify unexpected funds rate changes,” said Bernanke’s paper, co-written by former Fed economist Kenneth Kuttner.
“If we wanted to do the same thing today, we would not be able to use it,” Kuttner, a professor at Williams College in Williamstown, Massachusetts, said in an interview yesterday.
Using futures to predict reaction to moves in the central bank’s target rate is “pretty much out the window at this point,” he said, leaving only outside Fed watchers, trading on betting sites and a few other possible sources.
A few years ago, one could have comfortably taken a look at Fed Funds futures and predicted Bernanke’s action, but that relationship may not hold any longer. In just a little while, we’ll see who’s right - the market, or the experts.
October 29th, 2008 at 2:19 pm
Answer: the economists.
October 29th, 2008 at 3:57 pm
Ronit, what was your prediction?
I only heard via general news that .50 was expected. I really would have been surprised with .75. I, who am very untutored in this area, would have thought .75 would give the wrong meta-communication.
Thanks for increasing my knowledge with background on economic predictors.
October 29th, 2008 at 4:27 pm
My prediction was for 50 bps, because I too felt that the futures market was being… weird.
Here’s how the market reacted this afternoon, and I’d also classify this under the heading of “just plain weird”:
October 29th, 2008 at 4:49 pm
Ronit- Another question that you might be able to answer empirically, or at least you might have the numbers.
Many times, enough that I would guess 75-90% of the times when a rate cut is predicted, the dow goes down on the same day that the prediction comes true. Am I mis-remembering or is this true. And, why with expected good news would investors sell?
October 29th, 2008 at 5:10 pm
Any chance you might recall the source for the idea you quoted?
Here, by the way, is the original Bernanke-Kuttner paper:
http://www.federalreserve.gov/pubs/feds/2004/200416/200416abs.html
The whole paper is worth a read, but pages 7-8 seem relevant to answering your question - the scatterplot (keeping in mind that this data is a little old by now) doesn’t seem to confirm the relationship you suggest…
Key quote:
For the data points where “surprise”= 0, the change in the S&P seems tightly clustered between -0.5% and +2%… with most of the non-surprise events leading to a slightly positive change in the S&P.
October 29th, 2008 at 11:34 pm
Thanks for the link.
And, no, I don’t recall the source. It could have been anything from a friend making a comment to reading something in a non-professional journal.
October 30th, 2008 at 9:42 am
In the 50’s the Williams Economics Department had a charming lefty named John Power. Power introduced us to a Marxist concept called the “Capital Strike”. The idea of the capital strike was that Capital in its battle with Labor could get the Fed and Treasury to do its bidding by withdrawing capital from the market so that the Dow and bond markets would collapse. That is going on now. Unless the Fed had given the street its .5 % rate cut the money interests would have brought the Dow doen enough that it would have had to surrender. There is no way the experts can stand up to a capital strike.
October 30th, 2008 at 12:04 pm
In five words, it was in the market.
October 30th, 2008 at 10:09 pm
Frank,
Exactly.
Henry
October 30th, 2008 at 10:14 pm
Great minds run in the same vein.