Why Fed Funds Futures Might Not Reflect Fed Expectations

If you want to play around with short-term credit in the futures market, there are lots of ways of doing that. On the other hand, if you want to express an opinion on where the Fed funds rate is going to be at some point in the future, there's a very specific way of doing that: Fed funds futures. So to get an idea of where the market thinks that the Fed is going to be in six or nine months, all you need to do is look at the Fed funds futures contract. Right? Maybe not, says Lou Crandall, quoted today by the WSJ (via Barry Ritholtz).

Lou Crandall, chief economist at Wrightson Associates, says while such action is commonly attributed to increased expectations of a Federal Reserve rate cut, that would be a mistake. The real reason, he said, is that investors are fleeing risk and seeking safety in Treasury bonds and bills and other high-quality paper, sending their prices up and yields down. As a result, the entire yield curve has shifted down. To maintain parity with that lower yield curve, the implied federal funds rate also has to drop, he says...
“The amount of money backing people who have opinions about where the Fed will be in six or nine months is dwarfed by the amount of real money being invested in short-term credit markets.”

This does make a certain amount of sense. After all, no one thinks that currency futures reflect where the market "thinks" a certain currency will be trading at some point in the future: everybody knows that they reflect nothing more than interest-rate differentials between two different currencies.

And it also helps explain why the market was "pricing in two rate cuts by year-end" even when precious few economic forecasters were predicting such a thing.

But I'm still not clear on why people would use Fed funds futures, specifically, to lock in future returns.