The Mentor Journal
Bond Markets
How Do Fed Funds Futures Work?
crystal ball with percentage sign inside to illustrate interest rates based on fed funds futures
By Chris Nelson
June 2, 2022
Reading Time: 5 minutes

If you’re working in banking and finance, you’ll no doubt find yourself talking about the Federal Reserve, the FOMC, and the interest rate environment.  For finance geeks like us, keeping up on the latest from the Fed is on par with following your favorite sports team or professional athlete.  We just can’t help ourselves!

As you follow the market’s interest rate expectations and try to understand what actions the FOMC is likely to take, you’ll encounter a lot of financial media discussion about the Fed funds futures market.  Understanding Fed funds futures and how to analyze the information about them can help us better understand market expectations for what it believes the Fed is likely to do.  Let’s explore Fed funds futures and how to analyze them.

What Are Fed Funds Futures?

We’ll begin by defining what Fed funds futures are.  Fed funds futures are contracts based on the Fed funds rate, which is the overnight rate at which banks lend money to each other and the primary benchmark rate the Federal Open Market Committee (FOMC) uses to implement monetary policy. 

The futures contracts are traded on the Chicago Mercantile Exchange (CME) and are available for various maturities, ranging from overnight to one year.  Investors use these contracts to hedge against changes in interest rates or speculate on the future direction of overnight rates. 

How Fed Funds Futures Pricing Indicates the Expected Interest Rate

Fed funds futures contracts trade at a discount to their face or par value.  The difference between the price and par represents the average effective Fed funds rate until the contract expires at the end of each month. 

For example, as I’m writing this, the June Fed funds futures contract is priced at 98.9175.  If we subtract that amount from par, or 100, we can estimate that the average effective Fed funds rate between now and contract expiration on June 30 is about 1.08%. 

Calculating a Future Rate for Fed Funds

Now let’s take things a step further.  The current effective Fed funds rate is 0.83%, and the average for June is 1.08%.  That means the market expects the Fed funds rate to rise before the end of the month. 

With the next FOMC meeting scheduled for June 15 and doing a little weighted average math, we can use the current rate and the average to solve for the effective Fed funds rate during the second part of the month.  It comes in at 1.33%, which is half a percentage point, or 50 basis points, higher than the current rate of 0.83%.  As a result, we can determine that the market is anticipating that the FOMC will raise the Fed funds rate by 50 basis points at the June meeting.

Fed Funds Futures Tools

Okay, so you’re probably sitting there thinking, “Chris, I can see how that can be helpful.  But who has time for all that math and calculating!” And you know what – you’d be right. 

But here’s the good news – you don’t have to do all that work.  I’m going to share with you a couple of resources based on Fed funds futures data that you can use to determine what the market expects the Fed to do with short-term interest rates.

Resource #1: Bloomberg’s “WIRP” Screen

The first resource is from Bloomberg.  It’s called the WIRP screen, which stands for “World Interest Rate Probabilities.”  You can pull up the WIRP screen on the Bloomberg terminal or ask your broker for a screenshot. 

The WIRP screen takes the information for all Fed funds futures contracts being traded and calculates probabilities for moves by the FOMC at their next meeting as well as future ones.  The table of information that Bloomberg provides includes the number of hikes or cuts at each meeting, with each move equal to 25 basis points, the percentage probability of a move, and the implied overnight rate and change.

Bloomberg WIRP screen showing Fed funds futures (Source: Bloomberg)

One thing I like about the Bloomberg WIRP screen is that you can pull up historical information for the past year.  So if you wanted to compare the Fed funds futures outlook today with a month ago, for example, you could get that information easily.

Resource #2: Chicago Mercantile Exchange’s “FedWatch” Tool

Another available resource comes from the CME itself.  The CME’s FedWatch Tool also provides probabilities and information based on the Fed funds futures market data. 

One thing I want to point out is that the methodologies used to calculate the probabilities are slightly different between Bloomberg and CME.  Without doing a deep dive, CME uses something called conditional probability, which can sometimes create a little confusion in terms of probable rate moves by the Fed. 

Personally, I prefer to use the Bloomberg WIRP screen because the information feels a little more intuitive to me.  And as I mentioned earlier, even if you don’t have access to a Bloomberg terminal, your broker can grab a screenshot of the information and have it in your inbox pretty quickly.

Can Fed Funds Futures Predict Future Rates?

As I mentioned earlier, these resources allow you to look at current and future Fed meetings.  While being able to see what the market expectations for FOMC meetings in six or nine months might be nice, I want to caution you against treating that information as highly accurate. 

When analyzing Fed funds futures, my rule of thumb is to pay attention to the next couple of upcoming meetings and stop there.  That’s because the accuracy of the data gets what I’ll call a little “squishy” as you move further and further into the future.  It’s like trying to make personal plans using a long-range weather forecast.  It might be correct, but the possibility of it being less accurate increases as you move further into the future. 

It’s also important to remember that what the Fed funds futures market shows us are just expectations.  When the time comes, the actual Fed decision could turn out to be different from what the market expects.  The futures contracts will shift as market sentiment does, so always keep in mind that Fed funds futures aren’t a crystal ball.  They’re indicative of what may happen but not necessarily predictive of what the FOMC will do.

Fed funds futures can be a helpful tool for analyzing the market’s expectations for Fed policy.  Using the information available on the futures contracts can help us understand what could happen with short-term interest rates.  But Fed funds futures are just one tool in the financial market toolbox, and a Fed watcher should use them alongside other information sources to get a well-rounded view of what might happen at the next Fed meeting.

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