- Three years’ time is ages in markets. Especially when it comes to central bank forecasting. But we’re going to give it a shot regardless. Inspired by our March 31 Comment, in which we used a simple Taylor rule model to make sense of USD OIS pricing, we will be doing a similar exercise for OIS pricing of key ECB policy rates today. In the March 31 Comment we concluded that USD OIS had priced in all the good news for the next several years. The model showed that the rate hike priced in two years from now would vindicate the most hawkish forecasts on the FOMC. Put differently: true to historical pattern, the market is erring on the side of optimism when it comes to pricing in the future federal funds rate.
- The rule-based model for the Euro Area with the best track-record for use in forecasting ECB policy rates is the so-called Orphanides-Wieland model. It’s named after the former Cypriote ECB Governing Council member Athanasios Orphanides and monetary economy professor Volker Wieland, who moonlights as an ECB watcher. The models is quite similar to the Taylor rule, except that the inputs are the inflation and GDP forecasts from the ECB’s quarterly survey of sell-side forecasters. Specifically, the inputs are the 1-year and 2-year ahead inflation and GDP forecasts . The biggest difference between the Taylor rule and the Orphanides-Wieland rule is that the latter is forward looking. It uses forecasts to ‘predict’ ECB policy rates up to four quarters ahead. The former is based on the most recent actual data points. Thus, the Taylor rule, only gives an estimate what the central bank policy rate should be in the present. Or the most recent past to be more precise.
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