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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
[TOPICS: MMUFE$,M$U$$$,MX$$$$,M$$FI$,MN$FI$,MN$MM$]
To read the full story
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Why MNI
MNI is the leading provider
of intelligence and analysis on the Global Fixed Income, Foreign Exchange and Energy markets. We use an innovative combination of real-time analysis, deep fundamental research and journalism to provide unique and actionable insights for traders and investors. Our "All signal, no noise" approach drives an intelligence service that is succinct and timely, which is highly regarded by our time constrained client base.Our Head Office is in London with offices in Chicago, Washington and Beijing, as well as an on the ground presence in other major financial centres across the world.