Six months of Fed Funds market expectation in ten seconds.
The US Fed has hiked rates several times in the last year. What was the market's expectation for those hikes six or twelve month before they happened? To estimate that, you can ask many market participants about their expectations every day and then average the answers. This is the polling approach.
Instead of asking where their mouth is, you can also look where their money is. Interest rate derivatives are the most liquid financial instruments, worth a lot more than many mouths. How do you read the market expectation in derivatives? The overnight-indexed swaps (OIS) are linked to the Effective Federal Fund Rates (EFFR). Those swaps are liquid and usually trade with standard tenors like 1, 2, 3-months. It is possible to extract from those instruments the market expectation about futures rates. This can be done in a systematic way using curve calibration on those OIS with interpolation mechanism that imply constant rates between FOMC meetings and allows for jumps on those dates.
I have done the curve calibration on a daily basis on a 6-month period. Each day the curve is calibrated to market OISs, taking into account the FOMC dates in the next year. The forward rates for each day over the year after the calibration is computed and displayed in a graph.
Putting together those graphs produces a 10 seconds movie representing the market expectation over a 6-month period (from June 2017 to January 2018) of the next 12-month on calibration date.
In the graphs, the actual EFFR fixing as published by the Fed are represented in red. They represent the realized rates with full insight. For each date, the expectation for each day in the next 12-month is represented in blue. We insist that the two colors represent very different things, the red is backward looking after the date (realized path), the blue is forward looking for the next 12 months and updated each day.
With this representation you can see the market expectation changing (slightly) each day and in most cases converging to the FOMC decisions.
The movie can be found on YouTube at https://youtu.be/pqv3sIVjz7c
Don't hesitate to contact me for production implementation of those curve calibration methods. The technical description of the method can be found in Section 5.11 of my Interest Rate Modelling in the Multi-curve Framework book.
Note: The movie was produced with is a simplified curve description template. It does not include month-end expected behavior. Exogenous intra-month seasonality can be added to the curve to obtain an even more realistic forward behavior (Section 5.9.4 in the book).
Instead of asking where their mouth is, you can also look where their money is. Interest rate derivatives are the most liquid financial instruments, worth a lot more than many mouths. How do you read the market expectation in derivatives? The overnight-indexed swaps (OIS) are linked to the Effective Federal Fund Rates (EFFR). Those swaps are liquid and usually trade with standard tenors like 1, 2, 3-months. It is possible to extract from those instruments the market expectation about futures rates. This can be done in a systematic way using curve calibration on those OIS with interpolation mechanism that imply constant rates between FOMC meetings and allows for jumps on those dates.
I have done the curve calibration on a daily basis on a 6-month period. Each day the curve is calibrated to market OISs, taking into account the FOMC dates in the next year. The forward rates for each day over the year after the calibration is computed and displayed in a graph.
Putting together those graphs produces a 10 seconds movie representing the market expectation over a 6-month period (from June 2017 to January 2018) of the next 12-month on calibration date.
In the graphs, the actual EFFR fixing as published by the Fed are represented in red. They represent the realized rates with full insight. For each date, the expectation for each day in the next 12-month is represented in blue. We insist that the two colors represent very different things, the red is backward looking after the date (realized path), the blue is forward looking for the next 12 months and updated each day.
With this representation you can see the market expectation changing (slightly) each day and in most cases converging to the FOMC decisions.
The movie can be found on YouTube at https://youtu.be/pqv3sIVjz7c
Don't hesitate to contact me for production implementation of those curve calibration methods. The technical description of the method can be found in Section 5.11 of my Interest Rate Modelling in the Multi-curve Framework book.
Note: The movie was produced with is a simplified curve description template. It does not include month-end expected behavior. Exogenous intra-month seasonality can be added to the curve to obtain an even more realistic forward behavior (Section 5.9.4 in the book).
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