Watching the FedWatch
51 Pages Posted: 16 Jan 2025 Last revised: 27 Jan 2025
Date Written: January 10, 2025
Abstract
The popularity of the CME FedWatch as a tool for forecasting monetary policy has increased rapidly. We investigate its statistical and economic value for market participants. Our analysis shows that this simple binary model can predict the Federal Open Market Committee (FOMC) rate decisions with an 88% accuracy 30 days before FOMC meetings. On the other hand, conventional predictions based on Fed fund futures result in a 75% accuracy. A simple backtesting procedure demonstrates that this 13% accuracy improvement translates into significant economic gains. Further empirical evidence indicates that the tool effectively reduces uncertainty ahead of FOMC meetings, mitigating the well-documented pre-FOMC drift. Despite its strong predictive power, the FedWatch has remained largely overlooked until recently, according to traffic data. We explore several mechanisms to explain why market participants have not fully exploited such tools. One key reason lies in the fact that bond yields on FOMC days are predominantly driven by unexpected rate surprises, which remain unpredictable even for sophisticated investors.
Keywords: Fixed Income, Financial Risk Management, Monetary Policy, Fed Funds Futures
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