The Enrico Method: Forecasting Fed Funds with SOFR

The Origin of the Enrico Method

The Enrico Method is NeuralEdge's proprietary algorithmic innovation for calculating Federal Reserve rate probabilities. It is named after its creator and is built on a key observation that significantly improves forecast accuracy compared to the traditional approach.

The Problem with the Traditional Method

The standard method (also used by the CME FedWatch Tool) calculates rate-change probabilities by comparing the OIS forward rate with the current Federal Effective Rate (EFFR).

The problem: the EFFR is a volume-weighted average of overnight transactions in the federal funds market. This rate can fluctuate within the Fed's rate corridor (target range) for technical liquidity reasons, without reflecting any change in monetary policy.

The SOFR Solution

The Enrico Method replaces the EFFR with SOFR (Secured Overnight Financing Rate) as the reference rate for calculating the first meeting. The reasons:

1. Greater representativeness: SOFR is based on roughly $1 trillion of daily transactions in the repo market, versus about ~$80 billion for the EFFR. The sample is 12 times larger.

2. Less technical noise: because it is based on collateralized (repo) transactions, SOFR is less prone to distortions from technical factors such as tax deadlines or quarter-end window-dressing operations.

3. Forward-looking: SOFR incorporates market expectations of future Fed decisions more quickly.

The Formula

For the first FOMC meeting on the calendar, the probability of a cut is calculated as:

P(cut) = (current_SOFR - Forward_Rate_at_meeting) / standard_increment

Where the standard increment is typically 25 basis points (0.25%).

For meetings beyond the first, the Enrico Method converges to the traditional OIS approach, since the time distance makes the choice of the current reference rate irrelevant.

Backtest Results

We backtested the Enrico Method over 5 years of data (2021-2026), comparing it with the traditional EFFR method:

Integration with NeuralEdge

The Enrico Method is natively integrated into NeuralEdge's Interest Rates Hub. Every time you view the probabilities for the next FOMC meeting, the calculation automatically uses SOFR for the current meeting and OIS for future meetings.

Conclusion

The Enrico Method represents a small but meaningful improvement in the precision of Fed rate forecasts. It is exactly the kind of edge that makes the difference over time - hence the name NeuralEdge.