Fed Fund Rate futures curve

“The Fed is certainly moving forward with plans to normalize interest rates.” We keep on hearing that, we believed it in the past and we believe it now. We believe that the Fed believes and that, in fact, this means something.

Should we become more suspicious and less trusting given history? Let’s take a look.

We can draw some limited information based on Fed Funds futures and their historical movement. These are cash settled contracts based on the average daily effective Fed Fund rate during the course of the delivery month, which is traded up to 3 years into the future (we will only use 2 years ahead). I write “limited information” since there are other price-important factors apart from expectations. Using the following Fed Fund Rate futures curve animation plot, we can roughly judge what is the expected direction and pace of Fed hikes. A steep upward sloping curve would mean that there are expectations for future rapid increase in rates. Using the animation we can get a feel how those expectations evolve over time.

Basically ever since the global financial crisis the long end of the curve is constantly pushing upwards. Sometimes with a moderate but mostly with a steep slope. Meanwhile the short end.. well, you know.

Reiterating, should we become more suspicious and less trusting given history? But (maybe) this time it is different.

Code:


# Function needed
firstDayMonth=function(x)
{           
  day = format(x,format="%d")
  monthYr = format(x,format="%Y-%m")
  y = tapply(day,monthYr, min)
  first=as.Date(paste(row.names(y),y,sep="-"))
}

# Data here: https://dl.dropboxusercontent.com/u/9409065/ff_ffcurve.RData 
head(ff) ;  head(ffcurve)
temp <- firstDayMonth(ffcurve[,1])
temp2 <- match(temp,ffcurve[,1])
dtemp <- as.matrix(ff[temp2,])
head(dtemp)
seqq <- c(1:24)
lwd1=2
plot(dtemp[55,]~seqq,ty="l",col=1,lwd=lwd1,ylim=c(min(dtemp,na.rm=T),max(dtemp,na.rm=T)),
     ylab="",xlab="Maturity (Years)",bty="o")

par(mfrow = c(1,1),bg="white")
for (i in 1:dim(dtemp)[1]){
  plot(dtemp[i,]~seqq,ty="l",col=1,lwd=lwd1,ylim=c(min(dtemp,na.rm=T),max(dtemp,na.rm=T)),
       ylab="",xlab="Maturity (months)",bty="o", main=
         paste("Federal Funds Futures Curve; ",substr(as.character(ffcurve[temp2[i],1]),1,7)))
  grid(col='grey',equilogs=F)
#  dev.copy2pdf(file=fname)  # Insert here where you want to copy to
}