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Title: Interpreting survey-based federal funds rate forecasts: how accurate are they in reflecting market expectations?

Authors: Max Kwong; David Leung; Alfred Wong; Jiayue Zhang

Addresses: Research Department, Hong Kong Monetary Authority, 55/F Two IFC, 8 Finance Street, Central, Hong Kong ' Research Department, Hong Kong Monetary Authority, 55/F Two IFC, 8 Finance Street, Central, Hong Kong ' Research Department, Hong Kong Monetary Authority, 55/F Two IFC, 8 Finance Street, Central, Hong Kong ' Research Department, Hong Kong Monetary Authority, 55/F Two IFC, 8 Finance Street, Central, Hong Kong

Abstract: What the market thinks is most likely to occur is not necessarily what the market expects to occur. This paper explains why most of the surveys of federal funds rate outlook deviate substantially from the true market expectation, especially as the forecast horizon increases. Surveys often ask participants for their forecast of the 'most likely outcome', which differs from the expected outcome. The latter has to take into account not only the most likely outcome but also those less likely to occur, that is, weighing all the possible outcomes by their probabilities. In a tightening (easing) cycle, the most likely outcome tends to be higher (lower) than the expected outcome, leading to a false impression that the fed will tighten (ease) more than what the market expects. It is only when the chances of rate hikes and rate cuts are roughly balanced that surveys reflect the true market expectation.

Keywords: federal funds rate; survey-based forecast; market-based forecast; interest rate expectation.

DOI: 10.1504/IJMEF.2020.105335

International Journal of Monetary Economics and Finance, 2020 Vol.13 No.1, pp.68 - 88

Received: 08 Mar 2019
Accepted: 17 Oct 2019

Published online: 15 Feb 2020 *

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