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Futures Market Forecast of a Federal Funds Rate Increase Likely to be Appropriate

Monday, December 20, 2010

According to the federal funds futures market, the Fed will begin raising rates sometime next year—with the federal funds rate reaching about ½ percent by December 2011. In fact, rising rates next year has been the implicit forecast of the futures market for the past year—except for the month of October during which many FOMC members were promoting quantitative easing. As this chart of the price of a December 2011 futures contract shows, a year ago the forecast was for a funds rate of over 2 percent next by the end of 2011. (The implicit forecast is obtained by subtracting the price in the chart from 100). Expectations of tightening have been rising again since the start of November, though thus far by a small amount.

This forecast is consistent with the Taylor rule and most recent forecasts for GDP growth and inflation. In fact, in my view it understates the interest rate that is likely to be appropriate by next December.

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