At the end of June 2016, the futures markets expected the fed funds to be at 0.41% one year later (end June 2017) but the effective fed funds on 30 June 2017 was 1.06%, ie 65 bps above the expected level. Actually, over the past year, the markets have persistently underestimated what the Fed would do. There are several reasons behind this. One reason is that the Fed has been rather opportunistic and hiked the fed funds when oil-related base effects were still very favourable. Another reason may be that markets are still reluctant to leave the “extremely slow fed funds tightening” mindset.
While FOMC members expect 4 fed funds hike before the end of 2018, the market only expects 2 hikes, which is probably too pessimistic. Recently, FOMC members shift their communication by saying that fed funds tightening would be justified for financial stability purposes. The Fed acknowledged the slowdown of core inflation but remains confident on the fact that the improvement of labour market conditions will exert an upward pressure on core inflation in the coming quarters. The Fed might gain some time by launching the partial non-reinvestment of its maturing assets (a very long-term process)