Hi Guys,

I came across this, and similar worded paragraph, since the start of the debate on whether the Fed will raise rates this year or next:

The probability the Fed will increase its benchmark by its Dec. 15-16 meeting is 72 percent, according to futures data compiled by Bloomberg. The calculation is based on the assumption the effective federal funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent.

Does anyone know how the probability is calculated?

Thanks a million!

For starters, the probability is between 0 and 1.

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I'm not exactly sure how this is done, but here's a shot:

Let's say Dec futures on the fed funds imply a rate of 0.27 versus the current rate of 0.125 (assuming the average sits right in the middle of the current range of 0 to 25 bps). Now if we assume after liftoff the rate (r_lo) = 37.5 bps, then the probability that we will have the liftoff is given by the simple calculation P = 27/37.5 = 72%

Anyway, there's a guess for you. As you can see there is one serious assumption that has to be made: the rate after liftoff, but it is probably known within a reasonable range (10-25 bps/increase seems right).

Above doesn't look right to me. If your no hike scenario is 12.5bps and a hike scenario is 37.5 bps, then FF at 27bps and probability of 72% would be a positive expected value: (37.5-27)0.72 + (12.5-27)0.28 = 3.5. Unless you think betting for/against the hike should be a non-zero expected pay-off, you gotta find such probabilities so that expected profit is 0. You should also go to the CME website and read the contract specification to decide if you really want to use the Dec contract and not Jan.

There are other, more sophisticated methodologies out there (e.g. http://www.snb.ch/n/mmr/reference/sem_2005_09_carl...),but this is a good start.

There is something funny about this quote... How do they get a sense of what the broad mkt is expecting, if it wasn't with FF futures?

Makes no sense and I don't think it's a matter of comparing FF futures vs Eurodollars.

I agree. I re-read the article a few times and looked at other online resources to understand what it was saying. I think it was comparing how the probability changed over time.

WIRP

Good article, however, just because we can doesn't mean we should. In the absence of inflation it's difficult to make the argument that a more contractionary (relative to today) is needed. I'd also highlight the incredibly weak industrial end markets (see q3 earnings calls).

Yes, yes it should. In fact, the possibility of a rate hike in 2016 should probably also be ignored. Doves gonna dove.

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