TL;DR

• Fed funds futures are CME contracts that settle to the average daily effective fed funds rate over a calendar month, priced as 100 minus that rate.
• Because the price is a rate forecast in disguise, you can back out what the market expects the Fed to do at each meeting, which is exactly what the widely quoted probability tables do.
• Those probabilities are a market price, not a forecast from anyone in particular, and they contain risk premium as well as expectation. They also assume moves come in 25 basis point increments.
• The market's rate path has been badly wrong at every major turning point of the last two decades, which is precisely when getting it right would have mattered most.

What Is Fed Funds Futures: The Simple Version

Suppose you want to bet on what the Federal Reserve will do in November. There is no contract called "will the Fed cut in November", so the market built the next best thing.

The CME lists 30 Day Federal Funds futures, ticker ZQ, with $5,000,000 of face value per contract. Each contract corresponds to one calendar month and settles to the average of the daily effective federal funds rate over that month. The quoting convention is deliberately simple: the price is 100 minus the rate. A contract trading at 96.50 implies an average effective rate of 3.50% for that month.

That single convention is what makes the whole apparatus work. If you know the current rate and you know what the contract implies for the average across a future month, you can solve for what the market thinks the rate will be after the meeting inside that month. Do that across the strip of contracts and you have the market implied policy path, all the way out a year or more.

The probability tables you see quoted everywhere, the ones saying something like a 78% chance of a cut at the next meeting, are just this arithmetic presented for a general audience. They are not a survey, an economist's view or a leak from inside the Fed. They are a rearrangement of a futures price.

Why Fed Funds Futures Matter for Investors

Because the expected path of short rates is the anchor under the price of nearly everything else. Bond yields across the curve are, to a first approximation, the expected average of future short rates plus a term premium. Equity valuations discount future cash flows at rates that build off the same foundation. Currency crosses move on the difference between one country's expected path and another's.

The practical value is that it tells you what is already priced. This is the single most useful question in macro investing and the one most often skipped. If you believe the Fed will cut twice this year, that view is worth nothing unless the market currently expects fewer cuts. Being right about the Fed and wrong about the pricing loses money in both directions.

The mechanism through which this reaches markets is repricing rather than the event itself. Consider the standard pattern around a Fed meeting: rates are held unchanged exactly as expected, and the market still moves sharply. Nothing about the decision surprised anyone. What moved was the expected path for the meetings after this one, and that path lives in the futures strip.

Marcus's rule here: the news is never the decision, it is the distance between the decision and what was priced. A hold can be hawkish, a cut can be dovish, and only the futures curve tells you which.

How Fed Funds Futures Work: The Details

The mechanics are worth understanding, because the probability tables hide some real assumptions.

1. Settlement is a monthly average, not a point. The contract settles to the average daily effective rate across the whole month. If a meeting falls mid month, the settlement blends the old rate before the decision with the new rate after it, weighted by days. Extracting an implied post meeting rate means unwinding that weighting, which is straightforward arithmetic and a common source of amateur error.
2. Probabilities assume a fixed step size. The standard calculation assumes any move is 25 basis points. If the market is contemplating a 50 basis point move, a single implied rate is consistent with several different distributions of outcomes, and a probability presented as a single number quietly hides that.
3. Price includes risk premium. A futures price is what someone will pay to transfer risk, not a pure expectation. In periods of stress, hedging demand can push the implied path away from what participants actually believe is most likely. Treating market implied probabilities as unbiased forecasts overstates their precision.
4. The far end of the curve uses different instruments. Fed funds futures are most liquid in the near months. For expectations beyond roughly a year, three month SOFR futures and overnight index swaps carry the information, priced off a different but closely related overnight rate.

Now the part that matters more than the mechanics: the historical accuracy of this curve is poor at exactly the moments that matter. The market implied path has repeatedly failed to anticipate policy turning points, missing the speed of tightening cycles and then over anticipating the speed of the easing cycles that followed. This is not a criticism of the instrument. It is a property of any market price for an uncertain future: it aggregates current consensus, and consensus is at its weakest precisely when the regime is changing.

Bias Flag: Financial media presents rate probabilities with a precision they do not possess, quoting figures to a single percentage point as though they were poll results with a margin of error. They are a derived quantity from a market price containing risk premium. Read them as "roughly two thirds priced in" rather than "68%", and you will be closer to the truth than the person reading the headline.

How to Use This in Your Investing

Use the curve to check pricing before you form an opinion, not after.

Three practical habits:

1. Before you act on a macro view, find out what is already in the price. If you expect three cuts and the strip implies three cuts, your view earns you nothing. The trade lives in the gap between your expectation and the market's, and the futures curve is where you find that gap.
2. Watch the whole path, not the next meeting. The next decision is usually well telegraphed and mostly priced. The information sits six to twelve months out, where uncertainty is real and repricing is violent.
3. Treat sharp repricing as a signal about the regime. When the implied path shifts dramatically in a few sessions, that is the market changing its mind about the environment, and it typically precedes moves in credit spreads, currencies and long duration equities.

The rate path shapes the liquidity backdrop, and AC's Liquidity Tracker shows the other half of that picture: the balance sheet, the Treasury General Account and the reverse repo facility. Rates set the price of money and those three set the quantity, and neither half is legible without the other.

FAQ

Q: What exactly do fed funds futures track? A: The average daily effective federal funds rate over a specific calendar month. The contract is quoted as 100 minus that rate, so a price of 96.50 implies a 3.50% average for the month.

Q: Where do rate cut probabilities come from? A: They are derived from those futures prices. The implied monthly average rate is compared with the current rate to back out what the market expects after the meeting in that month, usually assuming 25 basis point increments.

Q: Are market implied probabilities accurate? A: They are an accurate reading of current pricing and an unreliable forecast. The implied path has repeatedly missed policy turning points, and it contains risk premium as well as expectation, so it should not be read as a pure probability.

Q: Why do markets move when the Fed does exactly what was expected? A: Because the decision was priced but the future path was not. Changes to the expected trajectory for later meetings, driven by the statement, the projections or the press conference, are what move asset prices.

Q: What instruments cover expectations beyond a year? A: Three month SOFR futures and overnight index swaps, which reference the secured overnight financing rate. Fed funds futures are most liquid in the near months and thin out further along the curve.