The predictive power of Fed funds futures contracts for overnight federal funds rates has not been exploited in term structure models. The combination of data on Fed funds futures with a dynamic term structure model can identify the distribution of monetary policy shocks following future FOMC meetings. The distribution of policy shocks exhibits cyclical changes in the uncertainty surrounding future FOMC meetings. The uncertainty is mainly driven by a “path” factor signaling information about future policy actions. The uncertainty is lowest when the path factor
signals a tightening cycle and highest in a loosening cycle. The uncertainty raises the risk premium in loosening cycle and lowers the risk premium in a tightening cycle, reducing the transmission of target changes to longer maturities. The results trace the information content of futures to hedging demand.
Update (2016): Fed Funds Futures and the Federal Reserve. Some older results were published in Developments in Macro-Finance Yield Curve Modelling (2014).