Fed Funds Probability
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Fed Funds Probability is the probability of Federal Reserve actions at upcoming Federal Open Market Committee (FOMC) meetings. At every FOMC meeting, the FOMC members decide whether to increase, decrease, or leave the Fed Funds rate unchanged after reviewing the economic conditions of the U.S. The financial markets constantly assess the Feds move by trading the CBOT (Chicago Board of Trade) Fed Funds futures contracts.
As such, the prices of the CBOT Fed Funds contract reflect the Fed actions and can be used to calculate the implied probability of Fed actions at each of the FOMC meetings. This phenomenon was perceived by Gerald Lucas and Timothy Quek, both fixed income strategists at Merrill Lynch in 1995. The article "Front-End Pricing Report Guide" was published by Timothy Quek and Gerald Lucas in the Merrill Lynch Global Fixed Income Research report in November 10, 1995. They created a financial model to calculate the probabilities at FOMC meetings and published the Fed Funds Probability reports to clients. Ever since, the financial market communities catch on and being constantly reported by financial media, such as CNBC, on the Fed Funds probabilities at the coming meetings.
The discovery of Fed Funds Probability has significant impact on the financial markets. Market makers and traders use this information to trade financial assets. Federal Reserve decision makers use this information to tell them what the market thinks. As a result, the shock to the financial market system is reduced dramatically as the markets adjust accordingly.
