US: How accurate are popular sources in forecasting Fed’s rate? - Wells Fargo

Analysts from Wells Fargo, used 11 years of historical forecast data from the Blue Chip Financial Forecasts, the FOMC and the fed funds futures market to compare the accuracy of three well-known forecasting sources in predicting the fed funds rate from 2007 to 2017. Their analysis supports previous findings that Fed Funds Futures are not always reliable predictive benchmarks. 

Key Quotes: 

“For all forecast sources, we take the year-ahead projected fed funds rate and compare it to the year-end actual fed funds rate for each forecast horizon. Both the FOMC and futures market forecasts have the smallest distance from the actual fed funds rate in five of the 11 years, while the Blue Chip forecasts have the smallest distance in just one year. In terms of directional errors, Blue Chip and the futures market tend to over-predict the actual rate more than 70 percent of the time."

“The FOMC’s projections have a more balanced 5-6 split on over- and under-forecasting the actual rate, respectively. This analysis largely supports our earlier findings that fed funds futures are not always reliable predictive benchmarks, as we now know this is the case from the magnitude and direction of forecast errors.”

“In terms of magnitude, futures market predictions never come within 5 bps of the actual fed funds rate, while the Blue Chip and FOMC forecasts each come within 5 bps of the actual rate three times. In terms of direction, the futures market consistently over-predicted the fed funds rate over the sample period.”

“Forward rates are unable to accurately predict actual rates because of the challenge in forecasting the risk premium. This observation could likely help explain why the futures market tends to over-predict actual rates, due to the need to over-compensate for the risk premium in the absence of complete information about the direction of the market.”

“Blue Chip and FOMC forecasts both come within 5 bps of the actual rate the same number of times, and the FOMC and futures market were tied for the number of years with the smallest distance from the actual value, even if the difference did not come within 5 bps. In sum, each forecast source has benefits and drawbacks when used as a benchmark for future realized rates.”