# Dec 16: FED rate hike?

Various news articles state that next Wednesday a rate hike by the FED was expected.

Yet when I look at fed-rate futures, nobody seems to expect that: http://www.cmegroup.com/trading/interest-rates/stir/30-day-federal-fund.html

Can someone with industry insight elaborate on what traders expect?

Verbal answers on what is currently expected regarding the FED's rate hike are also accepted.

To compute the exact probability of a rate hike involves some assumptions. For simplicity, let's ignore the difference between Fed funds target rate and Fed funds effective rate. Further, let's use the mid-point of the Fed funds target range as the target rate. For the first 16 days of December then, we are talking about an average realized rate of 12.5 bp (mid point between 0 and 25 bp). As of last Friday, Dec FF contract settled at 99.78, implying a rate of 22bp. To get to this settlement price, the target "rate" for the final 15 days must satisfy $$22 = \frac{12.5 \times 16 + r \times 15}{31}.$$ This suggests $r = 32.133333333 \text{ bp}$.
Now the only thing left is to compute the probability of a hike. Let $p$ be the probability of a 25 bp hike (from 12.5 to 37.5), and $1-p$ be the probability of being on hold (staying at 12.5). Then we have $$37.5 p + 12.5\times (1 - p) = 32.1333.$$ This implies that the market is pricing in a $(32.13 - 12.5)/25 = 79\%$ probability of a rate hike in December.
• Thanks for your detailed computation. However I am not sure how you can infer the probability from this average rate $r$. E.g. if $r>37.5$, you would have a probability $>1$. Probably you are assuming that the probability for a rate decrease is $0$, and that the rate will increase if only by $0.25$. Please elaborate on all your assumptions in the answer. – emcor Dec 13 '15 at 22:57