The Federal Open Market Committee (FOMC) does not aim to surprise markets with its rate decisions. However, participants can have differing opinions about the likelihood of the FOMC changing the fed funds rate at its scheduled meetings. These opinions can be observed in the CME Group FedWatch tool, which calculates the implied probability of a rate hike by the FOMC.

Less than two weeks ahead of the December 19 FOMC meeting, the probability of a rate increase remained persistently below 80 percent, lower than any recent meeting that resulted in a rate increase at the same point. As of December 6, the market implied probability of a rate increase at the December 19 FOMC was 70.6 percent. Ongoing volatility in recent months has tempered expectations about a rate hike, which may have implications for key futures markets.

Probability of a rate increase measured in days before FOMC decision where rates Increased

Market Volatility and Rate Probabilities

Market volatility has been pronounced in the fourth quarter. The S&P 500 has oscillated between positive and negative returns for the year since October, with daily changes swinging between 2.3 and -3.3 percent. This began about 70 days ahead of the December 19 FOMC, with the probability of a rate hike shown in the chart above.

Traders may believe that underlying factors causing stock market volatility could impact the FOMC's decision on a rate increase, and are positioning themselves accordingly, causing the falling probability of a rate hike as shown in the FedWatch implied probabilities. The December probabilities are unique in how low they've remained, but it is common for volatility spikes to impact traders' view on the probability of a rate increase.

Notably, the probability of a rate hike at both the March 21, 2018 and June 13, 2018 meetings dropped in the days leading up to meeting. Both dips correspond to spikes in volatility. Ahead of the March meeting, volatility returned to equities after a remarkably calm period. The S&P 500 dropped more than 4 percent on February 5 and yield on the 10-year Treasury Note fell nearly 5 percent.. Similarly, the probability of a rate hike in June fell when rates markets saw a spike in volatility in response to Eurozone turbulence on May 29, resulting in a 1.2 percent decrease in the S&P 500 and a 5.1 percent drop in the 10-year Treasury Note yield.

While the probabilities for both of these rate increases eventually recovered following their respective volatility spikes, as of December 6, the December probability has not recovered in the same manner.

Liquidity Response to a Rate Increase

With market volatility in 2017 near historic lows, the FOMC announcement of a rate hike on December 13, 2017 was widely expected. When the FOMC made its announcement at 1 pm CST, volume on the 10-year Treasury Note futures was lower than it had been at the start of the U.S. trading day.

In contrast, the March and June meetings, which both saw volatility spikes and rate hike probability dips ahead of the FOMC decisions, experienced higher volumes when rates were announced at 1:00 pm.

Ongoing volatility in the fourth quarter of 2018 has reduced the market-implied probability of a rate increase at the December 19 FOMC meeting. While previous rate hike probabilities since December 2017 have been impacted by market volatility events, none have been as low as 70.6 percent just two weeks from the FOMC meeting. The length of the current volatile period and the decrease in the probability of a rate increase this close to the FOMC are unique to the December meeting.

This supports the idea that market volatility can impact expectations of the FOMC's rate decisions and the subsequent response to the rate announcement.

Written by Jesy Beeson. Read more from the author here.

Read more stories like this on OpenMarkets. And for trader tools and resources visit:

(This article is sponsored and produced by CME Group, which is solely responsible for its content.)