As everyone has now figured out (if they didn't know before) markets aren't rational only efficient at averaging out everyone's expectations for the moment. The graph below charts out the yield on the Jun 2010 Eurodollar contract against the average Fed funds rate expected for summer 2010. Remember that the Euro contract is the yield on a three-month deposit made the day the contract goes to delivery, so the rate necessarily includes an expectation of where the funds rate will be plus a credit spread.
The market, in its infinite wisdom, is pricing in the Fed raising the funds rate several times between now and summer 2010. By August 10, the rate will be 1.5%. Considering all the depression talk that is quite a run to be discounting especially with no easing in credit spreads. At present that forward spread for summer 2010 is 47 basis points and has generally averaged around 42 basis points since May 10 -- when the winter scare was finally priced out of the market.
It is not quite clear to me how the Fed will be actively raising the base lending rate while banking spreads are still at recession-like wides. Looking at the level of the Eurodollar rate against the spread to expected Fed funds, someone is going to be wrong. The Fed will not be tightening, not for a long time and there is a very good chance that Bernanke will not even be running the Fed when summer 2010 rolls around. Reads to me like an arbitrage opportunity (at your own risk, etc.)