Predicting monetary policy using federal funds futures prices

In theory, prices of current-month federal funds futures contracts should reflect market expectations of near-term movements in the Federal Reserve's target level for the federal funds rate. However, empirical results show that such measures of market expectations are too noisy to predict day-to-day changes in the funds rate target; partly due to time aggregation problems, partly because they are affected by funds rate movements not directly related to monetary policy considerations. In particular, the futures market shows a large amount of systematic variation across months and trading days, variation that needs to be taken into account when predicting policy moves or extracting policy expectations. For the period from January 1994 to February 1998, the extracted expectations perform fairly well in predicting the target level that will prevail after the next meeting of the Federal Open Market Committee, expecially when adjusting for market regularities.