Predicting the Direction of the Fed's Target Rate

Predicting the direction of central banks' target interest rates is important for various market participants. This paper advances procedures for predicting the direction of the federal funds target rate using a dynamic extension of the multinomial logit model. I find that the 6‐month Treasury bill spread relative to the federal funds rate, the unemployment rate and the real GDP growth rate have superior predictive content for the direction of the target a week to several months ahead. When these variables are employed, lagged target changes do not provide additional predictive power. This suggests that the apparent positive serial dependence of the target changes is due to the Fed's systematic response to autocorrelated macroeconomic variables. Copyright © 2010 John Wiley & Sons, Ltd.