Editor's note: It's time to put the odds in your favor...

Many investors have no idea that Wall Street traders actually place bets on what they think the Federal Reserve will do with interest rates. And these predictions can help us individual traders make better investment decisions.

That's why Karina Kovalcik – senior quantitative analyst of our corporate affiliate Chaikin Analytics – says it's critical for folks to pay attention to what the "smart money" thinks the Fed will do moving forward...

In today's Masters Series, adapted from the August 22 issue of the Chaikin PowerFeed daily e-letter, Karina details the significance of the federal-funds rate... reveals how we can use this metric to improve our investment decisions... and discusses the possibility of a looming recession...

This Is How Experts Gamble on Our Future

By Karina Kovalcik, senior quantitative analyst, Chaikin Analytics

We've talked a lot about rising interest rates this year...

Out-of-control inflation is a dominant narrative these days. And of course, so is the Federal Reserve's attempt to tackle the problem. Just about everyone has an opinion on it...

In fact, just last month, I explained that figuring out the Fed's plan for its future meetings is the "right sign" for investors right now. The topic is inescapable – and critical.

But did you know that institutional-level traders place bets on the Fed? Even better, we can see the summary of these bets. And that can help us figure out what to expect.

So today, let's talk about the tool Wall Street uses to bet on the Fed. And more specifically, we'll look at exactly what these power players currently expect to happen next...

First, we need to define a few simple terms...

The first is the "federal-funds rate." The Fed sets this rate. It's simply the "overnight" rate at which banks borrow and lend their excess reserves to each other in the short term.

All other interest rates are based on this one number. It determines what regular folks like us pay when we borrow money from the bank. It dictates how much interest we get in our savings accounts. And it does the same things for businesses as well.

So even a small tweak to that one number can swing the economy in a big way.

And Wall Street can actively bet on what changes the Fed will make to that number. That leads us to the second term we need to define – "futures contract."

A futures contract is exactly what it sounds like. It's a financial agreement to buy or sell a specific item on a specific day in the future. Banks and high-level expert traders use futures contracts to hedge against market movements or to speculate.

A "fed-funds futures contract" is the combination of those first two terms. Banks and market experts enter into these contracts in order to speculate or hedge about what the Fed will do with interest rates at a designated point in the future.

Importantly, we can measure how many investors are betting each way at a given time. And we can use that number to figure out the probability of specific rate hikes.

In other words, we can see what Wall Street predicts will happen next at the Fed.

I'm not saying the experts are right every time. We are talking odds after all. But this data is still extremely valuable...

It gives individual investors like us access to information that we didn't previously know. That's critical because the big institutions use this data to make their investment decisions.

And fortunately, this data is available to investors like us in CME Group's FedWatch Tool.

The methodology used in the FedWatch tool can get a little in the weeds. You just need to know that it allows us to see in real time what Wall Street traders expect to happen.

Today, Wall Street traders are virtually certain that the Fed will act again in the coming week...

The FedWatch tool points to a roughly 86% chance that the Fed will boost the federal-funds rate by 75 basis points ("bps") on September 21. And it shows a 14% chance of a 100-basis-point hike.

In other words, these experts believe there's a 100% chance of at least a 75-bps hike next week.

Looking even further out, the FedWatch tool indicates a roughly 70% likelihood that the federal-funds rate will be at least 3.75% in November. That's 150 bps higher than the current range of 2.25% to 2.5%.

In short, Wall Street expects the Fed to continue raising rates in the months ahead. And as I've explained before, that approach will only hurt investors like you and me.

The Fed is on track to strangle the economy long past the decline of inflation. And that means the possibility of a prolonged recession is very real.

But until we know for sure, we're keeping an eye on how the experts place their bets. And right now, they're betting on higher rates.

Prepare accordingly.

Good investing,

Karina Kovalcik

Editor's note: In volatile times like these, many investors are wondering what to do with their portfolio. That's why you should circle Thursday, September 22 on your calendar...

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