Fed Funds Futures Offer Bond Market Insights

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Profitable bond trading opportunities arise when your expectations about Fed policy differ from those of the market. Therefore, with the Fed seemingly embarking on a series of interest rate cuts, it behooves us to appreciate how many interest rate cuts the Fed Funds futures market expects and over what period. Equally important, Fed Funds futures help us assess the market’s economic growth and inflation expectations.

Currently, Fed Funds futures imply the Fed will start cutting rates in September and reduce them by 2.25 percent to 3.09 percent in early 2026. From that point, the market expects the Fed to slowly increase Fed Funds to 3.50 percent. The limited rate cuts and relatively high trough in Fed Funds tell us the market is not pricing in a recession but a normalization of GDP with inflation running at or slightly above the Fed’s two percent target.

If the Fed Funds futures market is correct, the upside in bond prices may be limited, especially compared to prior easing cycles. However, suppose the market underestimates the probability of a recession or a sharper-than-expected inflation drop over the coming few years. In that case, there is significant upside potential in bond prices.

Fed Funds futures caveat

Before we provide historical context for what the Fed might do and a historical track record of Fed Funds futures estimates, it’s important to caveat that market beliefs about future Fed actions and, consequently, the economy and inflation can swing wildly.

The graph below shows that expectations for the Fed Funds rate at the coming September 24th FOMC meeting have whipped around over the past year. Fed Funds futures currently imply that the Fed will cut rates by 34 bps at the September meeting. This includes a 100 percent chance of 25 bps and a 36 percent (.34-.25)/.25) chance of 50 bps. Only two months ago, it was priced at a 50/50 chance of only one 25-bps rate cut. Furthermore, at the start of the year, the market thought the Fed would cut rates by 1.34 percent by next month’s meeting. The data suggest that the markets’ collective assessment of economic conditions can be volatile.

implied rate cuts