A rather green question...

I

Ivanovich

I'm curious, I read this today in Thompson:

Looking at the Fed funds futures this morning, investors are looking for a 75 bps cut to 4.50% by November. Odds have increased from last week when investors saw similar cuts in Q1. A further outlook shows 412% odds or certainty of a rate cut to 4.25% by June 08.
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How, exactly, do the Fed Futures rates work? When you see that the futures imply a 75bps cut by November, I think to myself that either I'm missing something in that the economy is that bad or that the futures don't really have an effect on the Fed's decisions. Can someone please explain?

Cutting 75bps by November would simply re-ignite the free money/lquidity problem and exacerbate the problem further. The Fed cannot be that dumb, can they?

Thanks in advance.
 
Thank you for taking pity on me. :)

So this being the case, how is it that on God's green earth, the Futures show a 75bps decline by November?
 
(1) Instead of thinking about buying or selling futures, think about borrowing or lending money instead. When the Fed provided liquidity last week, they were aggressively lending money in such a way that additional borrowers were only to be found at an interest rate 50-75 basis points lower. (2) The market generally "leads" the Fed in the shorter-term. Now seems to be a goofy situation with the August contract and the "target rate". (3) If other country's interest rates move in a similar manner, there shouldn't be a dollar/currency crisis. (4) 412% chance? Somebody's math is wrong. (5) The front-month Fed Funds contract is "governed" by the averaging-process. The deferred contracts trade on future expectations of future policy. I hope some of that helps.
 
Dec contract is 95.485, which means the average weighted expectation is for a fed funds rate of 100-95.485=4.515

Since that is the weighted average and the meeting is 11 days into the month, there is also a fixed likelyhood for the 1st 11 days of 5.25 (current fed funds rate), which means that the probability has to be greater than 100% for 4.5 to average out to overall weighted expectation of 4.515. I have the equation on my main liquidity cycle thread, but for anyone interested, I also noticed the latest "active trader" magazine covers this in detail.

"Trading Fed moves with binary options "
<img src="http://www.activetradermag.com/images/sept07/cover0907-141.gif" border="0" alt=""><br /></font></p></font></p></font></p>
 
Quote from Ivanovich:

A lot of it helps. I appreciate your comments (both you and the condescending Daddy :)
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And by the way, Ivanovich - as you are a fiery currency player - you might be also interested in this little piece of information :



Swap contracts on Japan's overnight call rate showed investors saw only a 20 percent chance of a BOJ rate rise at the Aug. 22-23 policy meeting, down sharply from a high of 75 percent last Thursday. The swap contracts also suggested investors were starting to have some doubts about the prospects of a rate rise next month, with the chances of a September hike seen at roughly 55 percent.
:p
 
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