Why do investors literally place bets on whether the Fed will raise interest rates?

You can make a bet on pretty much anything in this country, including Federal Reserve interest rate policy decisions. Fed Funds futures are where investors go to do that — and where everyone else can look to find out what markets think the Fed is going to do with interest rates.   

Fed Funds futures, run by the Chicago Mercantile Exchange, allow investors to bet on what interest rates are going to do.

“It’s a measure of expectations of how the Fed is expected to set monetary policy,” said Matt Luzzetti, chief U.S. economist at Deutsche Bank.

But Fed Funds futures aren’t just like gambling.

“I don’t know that I would think of it only as a bet, it serves fundamental purposes as well,” Luzzetti said.

Fed Funds futures let banks and other institutions hedge in case interest rates move unexpectedly. Basically, if you’re a company or a bank and a change in interest rates is going to cause you to lose money (for whatever reason unique to you) you can make bets that would help you if that happened.

“You have banks hedging their funding costs, you have asset managers hedging interest rate risk, all sorts of stuff,” said Matt Paniati, a senior analyst at Capital Advisors Group.

So lots of very important reasons for people to bet on the Fed’s interest rate policy. Still, some people just do it just for the betting.

“It’s really an interesting waterfall cascade of who trades them,” said James Iuorio, a director at TJM Institutional Services and Fed Funds futures trader. “It starts out with the people who have the genuine risk — like, anyone who has huge loan portfolios that needs to hedge that risk — and then speculators come in and market makers and individual traders.”

But over on the bleachers, watching all this betting go down, are people, governments, and businesses all over the world.

“It’s a very good way to see what investors are expecting, what markets are pricing in for the future path of rate cuts,” said Gennadiy Goldberg, head of U.S. rate strategy at TD Securities.

And you know who else would also like to know what markets are expecting the Federal Reserve to do? The Federal Reserve.

“It would never publicly admit this, but there is a feedback loop that goes on between the market and the Fed is constantly gauging the impact of its expected policy path,” said Paniati at Capital Advisors Group.

The Fed wants to make sure it’s getting its message across about what it’s doing. And if it sees markets are deviating from reality, it might occasionally step in with a speech or a press conference to reset expectations.