Federal Funds Rate projections. They expect what???

Hue Frame

Frame Funds Management

Following on from the article we wrote in December 2018, 'Outlook 2019' (found here), we outlined four key themes for 2019. The US interest rate path, implications of US-Sino trade negotiations, the European economic situation and Emerging market performance.

The focus of this wire is on the US interest rate path - where have expectations been, where are they now and where they are expected to go.

Where have expectations been?

At the start of 2016, the US Federal Reserve (Fed) expected to raise the Federal Funds Rate to 3.00% by the end of 2018 (refer to Chart 1).

Chart 1. Sources: Federal Reserve, Reuters. REUTERS GRAPHICS

However, in December 2018, the US Federal Funds Rate was sitting at 2.25-2.50%. This mismatch of expectations versus reality is consistent over history, where the Fed states they will raise rates more aggressively than what they inevitably deliver.

At the start of December 2018, rates were forecasted to increase three times in 2019, which would have brought the US interest rate to 3.00-3.25% (refer to Chart 2).

Chart 2. Sources: Federal Reserve, Reuters. REUTERS GRAPHICS

At that point in time, our view was that projections for three rate rises during 2019 were far too aggressive and that the Fed would have to revise their projections downwards. The justification for this view, was that ongoing US-Sino trade negotiations would impact global economic growth, which would cause the Fed to become more accommodative in their projections.

Since December 2018, projections for further rate rises throughout 2019 have continued to decline. At the end of Q4 2018, projections had dropped to two additional rates rises during 2019 (refer to Chart 3).

Chart 3. Sources: Federal Reserve, Reuters. REUTERS GRAPHICS

At the conclusion of Q1 2019, expectations had moved to rates staying constant during 2019 (refer to Chart 4). Notably, from Q4 2018 to Q1 2019, projections for the Federal Funds Rate at the conclusion of 2020 had dropped from 3.00-3.25% to 2.50-2.75%.

Chart 4. Sources: Federal Reserve, Reuters. REUTERS GRAPHICS

Where are projections now and where are they expected to go?

Currently the US Federal Funds Rate is 2.00-2.25%. The Fed cut rates at the start of this month, the first cut since December 2008. At the conclusion of Q2 2019, the Feds projections for the Federal Funds Rate at the end of 2020 had plummeted to 2.00-2.25% versus their Q4 2018 projection of 3.00-3.25% (refer to Chart 5).

Chart 5. Sources: Federal Reserve, Reuters. REUTERS GRAPHICS

We expect the next update of plot projections for 2019, due for release at the end of this quarter, to be ~50bps below their current projection. Our view is that projections for the Federal Funds Rate at the conclusion of 2020 are still far too optimistic and need to adjust more in line with where interest rate futures are projecting. At the time of writing,
interest rate futures are projecting an interest rate between 1.50-1.75% which indicates are 50 bps cut, while December 2020 interest rate futures are pricing in Federal Fund Rate of 1.00-1.25%.


Recent communication from the Fed has stated that they will adjust the Federal Funds Rate based on economic data, rather than based on a predetermined path. That being said, we note the recent contraction in the Flash Manufacturing PMI data (49.9 actual vs 50.5 expectations, above 50 demonstrates expansion, below 50 demonstrates contraction), the first in approximately a decade, showing that the economic situation in the United States is deteriorating faster than they may had anticipated.

This information is prepared by Frame Funds Management Pty Ltd (ACN 608 862 442) (Frame Funds, we or us) is a Corporate Authorised Representative (CAR No. 123 9068) of Primary Securities Limited (ACN 089 812 812 635) and is intended only for "wholesale clients" within the meaning of sections 761G and 761GA of the Corporations Act 2001 (Cth). This material is not intended to constitute advertising or advice (including legal, tax or investment advice) of any kind. These materials are not to be distributed to any person who does not qualify as a wholesale client and must not be copied, reproduced, published, disclosed or passed to any other person at any time without the prior written consent of Frame Funds. Primary Securities Ltd (ACN 089 812 635 635, AFSL 224 107) is the Trustee of, and issuer of units in, the Frame Futures Fund (Fund). In deciding whether to acquire, or to continue to hold, units in the Fund please read the current Information Memorandum available from Frame Funds. Past performance of the Fund is not a reliable indicator of future performance. The value of an investment in the Fund may rise or fall. Returns are not guaranteed by any person. Total returns are calculated before tax and after ongoing management costs. In preparing this information, we have not considered your investment objectives, financial situation or personal circumstances and therefore the Fund may not be suitable for you. Neither Frame Funds, Primary Securities Ltd, nor any of their respective related parties, directors or employees, make any representation or warranty as to the accuracy, completeness, reasonableness or reliability of the information contained in this publication or accept liability or responsibility for any losses, whether direct, indirect or consequential, relating to, or arising from, the use or reliance on any part of this material. Any rates of return, forecasts or estimates contained in this publication are not guaranteed. The content of this publication is current as at the date of its publication and is subject to change at any time. It does not reflect any events or changes in circumstances occurring after the date of publication.

Hue Frame
Frame Funds Management

Hue Frame is the founder of Frame Funds Management. Frame Funds is a quantitative funds management company, that manages assets for institutional and wholesale clients, and proprietary funds.

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