How to use Fed Fund Futures to Predict Rate Cuts.

We are 4 days away from the September Federal Reserve Interest Rate Decision, or the FOMC as it is properly known as. 

Fed chair Jerome Powell did cut rates by 25 basis points in August citing it was only a ‘mid cycle’ adjustment. He may wish he never said those words. The interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. The law requires banks to keep a certain percentage of their customer’s money on reserve, where the banks earn no interest on it.

This past week, Mario Draghi at the ECB also cut interest rates deeper into the negative (from -0.4% to -0.5%) AND also initiated a bond purchasing program of 20 Billion Euros per month…the confidence crisis looms. Many are already calling this QEternity because it is negative rates and stimulus forever. The real economy never improved and this is why a confidence crisis in governments, banks and the fiat money is coming. All central banks will be cutting rates and issuing new stimulus going forward. It is really a race to the bottom.

Knowing this, you have probably already determined what my opinion is for whether or not the Federal Reserve will be cutting interest rates come Wednesday.

I believe they will be cutting and it is not the end of it.

Interestingly, President Trump said he did not want a 1% rate cut, but now wants rates at 0 and even less. He became the first US President to call for negative interest rates in the US. He applauded Mario Draghi’s decision for cutting rates deeper into the negative and issuing stimulus.

The President still holds dear to the ‘strongest economy ever’ line, but again folks, when an economy is really strong central banks HIKE rates. When an economy is weak, they CUT rates. This is economics 101.

Going back to my prediction on the Fed cutting rates…how can we determine this? Yes we can look at the bond markets and also economic data, but this is where the Fed Funds rate comes into play.

What is the Fed Funds rate I hear you say? Investopedia defines it as ” The interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. The law requires banks to keep a certain percentage of their customer’s money on reserve, where the banks earn no interest on it.”

Essentially what banks have to pay each other when borrowing money from each other from their reserves held with the central bank, in this case the Federal Reserve.

So now we know this, we can look at the Fed Futures contract that is offered by the CME group. The link is :

The first thing you will notice is that there are different months. We of course will focus on the current month. As we get closer to that rate decision, the futures contract will provide us with more information.

So what we do now is we click the chart bottom and you will see this:

So how can we use this to determine what market participants believe the effective fed funds rate will be? You take 100 and subtract that from the contract price in this case 97.9575 and you get the Fed Funds rate that is expected. Then you compare the actual rate and you can determine whether a cut will happen.

What if you do not want to take the time and calculate this and compare? What if all the hard work is done for you and presented in a convenient way for you? Well good news. The CME group also has a Fedwatch tool. It can be accessed here:

You can see that everything is presented by month and you get a bar chart showing us the probabilities of a rate cut. On the top right we even have the percentages summed up.

So this is what we have for September:

This is how we can determine whether the Fed will be cutting rates, keeping them the same, or even hiking rates. 

You can see that the market has a 79.6% chance of a rate cut, while 20.4% chance of no cut (rates being unchanged).

Again, the closer we get to rate decision day, the more effective this data. It fluctuates when economic data is released. For example, this past week there was an over 90% chance of a rate cut, but after the jobs data and other macro data, the probability came down to 79.6%.

Now here comes the fun part. Put yourself in the shoes of the FOMC and Jerome Powell. Central Bankers do not want to surprise the markets. So when they see that 79.6% of market participants expect a cut, a lot of this is already priced into the US Dollar and US stock markets. If they cut sure there will be come moves due to the day traders playing the volatility of the news release, however most of the big money has already made bets on this rate decision awhile back.

If the Fed DOES NOT cut, then it would be a big surprise since only 20.4% of the market expects this. The other 80% would then have to close positions perhaps to gauge their next course of action. This would cause a lot of movement and volatility in the markets that the central bank wants to avoid.

Now some argue that the Fed does not look at this. That the Fed is the one that wags the tail. However, I believe and many others do too, that the Fed makes its decisions based on the market. They do not want to upset the market.

If you follow my work, then you already know my opinions on the current macro environment. This market is propped up by cheap money. There is nowhere to go for yield except stocks as interest rates move lower.

So let us look at October:

You can see that 34.0% of the market believes the Fed will ALSO cut in October briging the rate down to 1.50% (we are currently at 2%). 

But what this tells us is that market participants expect a 88.3% chance of rates being cut come October. While 11.7% believe there will be no rate cut from now until October. 

This is how we can use the futures to determine whether the Fed will cut interest rates or do nothing. I hope this info was useful to you as not only can it be used to increase your investments and your trading account, but also help in determining when the best time to take out a mortgage or loan will be. The Bond/Debt market is the largest and the most important. It warrants your attention.

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