Surreal illustration of market forces battling over the Federal Reserve.

Decoding the Fed: Are Futures Forecasts Misleading Us About Monetary Policy?

Reese Marlowe in Business & Economy August 2025 • 4 min read.

"Uncover hidden biases in federal funds futures and how they impact your understanding of market expectations."

Understanding the future direction of Federal Reserve policy is crucial for investors, economists, and anyone impacted by interest rates. A key tool for gauging these expectations is the federal funds futures market, where contracts reflect predictions about the future path of the federal funds rate. However, there's an ongoing debate: are these futures prices a pure reflection of market expectations, or are they distorted by risk premiums—the extra compensation investors demand for bearing uncertainty?

A groundbreaking paper by Albert Lee Chun and Olfa Maalaoui Chun challenges the conventional wisdom. They argue that what appears to be risk premiums in fed funds futures might actually be systematic errors in expectations. By comparing futures forecasts with survey forecasts (which reflect direct expectations), they reveal a surprising disconnect.

This article delves into their findings, exploring the implications of expectational errors versus risk premiums. We'll uncover how these biases can impact your understanding of monetary policy and what alternative approaches might offer a clearer picture of market sentiment.

The Risk Premium Puzzle: Are We Misinterpreting Market Signals?

Surreal illustration of market forces battling over the Federal Reserve.

The traditional view assumes that futures prices incorporate a risk premium. This premium is the extra return demanded by investors to compensate for the uncertainty inherent in predicting future interest rates. However, Chun and Maalaoui Chun propose a different perspective: much of what we interpret as risk premium might be driven by systematic errors in how market participants form their expectations.

To understand their argument, it's essential to distinguish between futures forecasts and survey forecasts:

Futures Forecasts: Derived from the prices of federal funds futures contracts. These prices reflect the collective bets of market participants on the future federal funds rate.
Survey Forecasts: Obtained from surveys of professional economists and financial experts. These surveys directly ask participants for their expectations of the future federal funds rate.

The key difference? Survey forecasts are generally considered to be free of the risk premium that taints futures prices. If futures prices accurately reflect market expectations plus a risk premium, then they should consistently differ from survey forecasts. However, Chun and Maalaoui Chun's research suggests this isn't always the case.

Rethinking Market Expectations: A More Accurate View of Monetary Policy

Chun and Maalaoui Chun's research prompts a re-evaluation of how we interpret market signals. By recognizing the potential for expectational errors to distort futures forecasts, we can gain a more nuanced understanding of market sentiment and the future direction of monetary policy. This research encourages further investigation into the sources of these expectational errors, ultimately leading to more accurate predictions and better-informed decision-making.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.2139/ssrn.2212675, Alternate LINK

Title: Adjusting Futures Forecasts Of Federal Reserve Policy: Risk-Premia Or Expectational Errors?

Journal: SSRN Electronic Journal

Publisher: Elsevier BV

Authors: Albert Lee Chun, Olfa Maalaoui Chun

Published: 2013-01-01

Everything You Need To Know

What exactly are federal funds futures and how are they used to gauge market expectations about monetary policy?

Federal funds futures contracts are agreements to buy or sell the federal funds rate at a specified future date. They're used to speculate on and hedge against changes in the Federal Reserve's monetary policy. The price of these futures reflects market expectations of the future federal funds rate, but may also incorporate a risk premium, or systematic errors in expectations. Understanding how to interpret these prices is crucial for anyone following interest rate trends.

According to Chun and Maalaoui Chun's research, how might federal funds futures forecasts mislead us about the Federal Reserve's policy intentions, and what are the implications of these potential distortions?

Chun and Maalaoui Chun's research suggests that systematic errors in expectations may significantly influence federal funds futures prices, potentially distorting our understanding of market sentiment regarding future monetary policy. This implies that what appears to be a risk premium in futures prices might actually be due to market participants making consistent mistakes in forecasting the federal funds rate. This distinction is crucial because it challenges the traditional view that futures prices primarily reflect expectations plus a risk premium.

What is the fundamental difference between futures forecasts and survey forecasts when it comes to predicting the federal funds rate, and why is this distinction important?

Futures forecasts are derived from the prices of federal funds futures contracts, representing the collective bets of market participants on the future federal funds rate. Survey forecasts, on the other hand, come from surveys of economists and financial experts, directly asking for their expectations of the future federal funds rate. The key difference is that survey forecasts are generally considered free of the risk premium that may taint futures prices. Chun and Maalaoui Chun's work leverages this difference to identify expectational errors.

If expectational errors are indeed present in futures forecasts, what does that suggest about the efficiency of financial markets, and what further research could be done to pinpoint these errors?

The existence of expectational errors, as highlighted by Chun and Maalaoui Chun, suggests that market participants may be making systematic mistakes in their forecasts of the federal funds rate. Identifying the source of these expectational errors can lead to more accurate predictions and better-informed decision-making. Further research into the factors causing these errors could involve examining biases in economic models, behavioral factors influencing expectations, or the impact of information asymmetry within the market. This is essential for refining our understanding of market signals and monetary policy.

How does recognizing the potential for expectational errors to distort futures forecasts change the way we should interpret market signals, and what alternative approaches might provide a clearer picture of market sentiment regarding monetary policy?

Recognizing the potential for expectational errors to distort futures forecasts encourages a more nuanced interpretation of market sentiment and the future direction of monetary policy. Rather than solely relying on futures prices as a direct reflection of market expectations, analysts should consider alternative approaches, such as incorporating survey forecasts and investigating the underlying causes of expectational errors. This more comprehensive approach can lead to more accurate predictions and better-informed decision-making for investors, economists, and policymakers alike.