MNI INTERVIEW: OIS, Fed Funds Futures Overstated Cut Chances

--Chicago Fed Paper Says Risk Premium Masks Pure Rate Forecast

By Greg Quinn

     (MNI) - Overnight index swaps and Fed funds futures may have overstated the

probability of Federal Reserve rate cuts, as they incorporate bets on declining

inflation and other risks, Chicago Fed economist Stefania D'Amico told MNI.

     Raw market quotes from Oct. 28-Nov. 1 signaled investors pricing in a Fed

rate cut around mid-2020, while adjusting for a risk premium D'Amico calculated

at -2 to -3 basis points per month showed no move was expected, she wrote in a

Chicago Fed Letter published Tuesday. That adjusted view is in line with what

FOMC officials have said about growth being solid enough after three cuts last

year to keep monetary policy on hold.

     "You should not take the messages from raw financial quotes such as OIS

rates or federal funds rates futures at face value," D'Amico said in a phone

interview Tuesday. "You should be careful about disentangling these two

components and trying to see what is the true underlying expectation and what is

the probable contamination from the risk premium."

     --RISK PREMIUM

     Using OIS data to generate probabilities of central bank rate moves has

become a popular tool at major banking houses, because they can instantly

capture the impact of a new speech or data report. Their results are often more

volatile than conventional economist surveys. MNI also publishes a PINCH model

of implied rate moves across major economies.

     The risk premium has changed in size over time, and turned from positive to

negative in an era of concern about slower inflation, D'Amico said. It's a good

idea to keep updating the models used to figure out the discrepancy, she said.

In addition, the risk premium has its own value and isn't just noise.

     "The inflation risk premium contains a lot of information, and so if, for

example, you are planning to hedge against inflation risks then it is important

also to pay attention to the risk premium," she said.

     D'Amico joined the Chicago Fed since 2013 and before that was senior

economist with the Board of Governors in Washington. The paper is not an

official view of the Chicago Fed.

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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