The Fed provides a quarterly “dot plot” with its monetary policy projections for the next several years that can help investors glean the Fed’s thinking about the future.
Understand why some think the dot plot has lost a bit of relevance as we emerge from the pandemic
How does the Federal Reserve make a point? By showing us a bunch of dots.
The so-called “dot plot,” more formally known as the “Policy Path Chart,” is published by the Fed four times per year (once per quarter in March, June, September, and December) after meetings of its 16-member Federal Open Market Committee (FOMC), the central bank’s policy-setting arm.
Each dot represents an FOMC member’s view (anonymously; no dots are “identified”) about where the benchmark fed funds rate should be at the end of the current year, plus a few years down the road. The dots go up and down a lot. At the end of 2018, for instance, the Fed had just finished a long stretch of rate hikes, and the plot showed two more anticipated increases in 2019 followed by a third in 2020. The idea was that rates would reach 3.1% by then, which would have been the highest since before the 2008 financial crisis.
As we know, it didn’t exactly work out that way. Even before the pandemic hit in early 2020, the Fed had pulled rates back slightly. It quickly dropped them to zero in March 2020 (the first time since 2015) as the pandemic sank its claws into the world economy. By March 2021, the dot plot showed a majority at the Fed expecting no hikes through 2023. Of course, that could change by the time you read this. That’s why it’s important to check the latest March, June, September, or December Fed meeting reports to get a sense of where consensus most recently stood.
Market professionals scrutinize the dot plots closely for clues about the Fed’s next potential move on interest rates and its longer-term outlook on the economy. Although the central bank is subject to frequent criticism, “the Fed is comprised of some pretty smart people, so it’s important to pay attention to what they’re telling us,” said Alex Coffey, senior specialist, trader group at TD Ameritrade.
The dot plots, according to the Fed, are based on FOMC members’ individual assessments of “appropriate monetary policy” to generate the levels of economic growth and inflation that meet the central bank’s objectives: maximum employment and stable prices. The Fed first made the dot plots available in 2012 as part of efforts to be more transparent about how it makes rate decisions.
Before you figure out how to connect the dots, so to speak, it helps to be able to find them.
That’s actually not too hard. Simply access the Fed’s home page. Under the Monetary Policy tab, select Meeting Calendars and Information. That will show you the list of the Fed’s most recent meetings.
Scroll down to the most recent March, June, September, or December meetings, which are the ones where a fresh dot plot is released. Select and open the PDF or HTML file under the header Projection Materials, and you’ll find a document that allows you to scroll down through two pages of economic projections.
However, it’s page three you’re looking for. That’s the home of the dot plot. Now that you’re there, you’ll see a chart that looks like it was designed on a Tandy computer sold at your local RadioShack store in the 1980s. If you squint, you’ll see a bunch of blue dots plotted across several years, with rates on the y-axis and dates on the x-axis. This is the heart of the matter.
Remember that policy projections change from report to report. For example, figure 1 compares the dot plot as of March 2021 to a pre-pandemic report from June 2019.
We’ll look at the March 2021 dot plot, but any would do if you’re simply trying to get the hang of how the process works as you assess whether the Fed leans toward loosening or tightening rates.
Before digging deeper, keep in mind that each member’s dot represents the middle of a range. They’re not meant as exact targets, and there’s no way to tell which dots are from which FOMC member. The Fed also isn’t bound at all by these projections, so it’s important to view them as a snapshot of where members think rates might be a year or two out, not where they’ll actually be.
The March 2021 dot plot covers the years shown at the bottom (2021 through 2023 in figure 1). There’s also a category called “longer run.”
Start with the current and following years, and remember not to put too much faith in anything you see. After all, FOMC members, like the rest of us, can only make educated guesses about where the economy might be in a year or two. Sure, their guesses are almost certainly a lot more educated than that of the average person on the street, but they are guesses nonetheless.
FOMC members are each asked to plot where they think rates will be at the end of each year. Keep in mind that going into the March 2021 meeting the benchmark rate was at a target range of 0% to 0.25%, and that didn’t change when the meeting ended.
Looking at the dot plot for that meeting, the median target rate for 2021 remained 0% to 0.25%.
In fact, the consensus for March 2021 showed no expected rise in the rate through 2023. But if you go to the trouble of actually counting those dots on your screen for each year (old fashioned, we know), you’ll see that four of the 18 FOMC members were looking for a rate hike at some point in 2022. For 2023, seven members saw a rate increase. That’s still a minority, meaning 2023’s average “dot” is still zero.
In a case like that, it helps to compare and contrast the current plot to the last one for a sense of direction. If you compare March to December, the four FOMC members looking for a rate hike at some point in 2022 compared with just one at the December meeting. For 2023, the March dot plot showed seven members expecting a rate increase, compared with five in the December forecast. So, it’s not exactly market moving but slightly more hawkish.
At the same time, by early May 2021, prices for CME Group’s (CME) fed funds futures contracts—which track expectations for Fed moves that you can check by using the CME Group’s FedWatch tool—implied about a 9% chance of the Fed raising rates any time in 2021. If the past is any precedent (something you should never count on, by the way), there’s almost no chance of a rate hike before 2022.
Next, consider what the dot plot can tell you about history. Go back once more to the June 2019 dot plot, from almost a year before the COVID-19 pandemic. That one projected the fed funds rate would be in a range between 1.5% and 2.5% by the end of 2020 and possibly a tad higher by the end of 2021. We all know how that worked out (it’s been at virtually zero since the pandemic reached the United States in March 2020), and it’s a good object lesson in how much faith to put in these long-term projections: not too much. Sure, a pandemic doesn’t happen that often, but lots of smaller things can cause past projections to look dated very quickly.
The “longer run” category assumed more importance coming out of COVID-19. It provides a sense of what most FOMC members arguably consider “normal” interest rates if the economy ever returns to more typical levels of inflation and unemployment. Judging by the dot plot for “longer run” in March 2021, expectations center around 2.5%. For a little context, 2.5% was the highest that rates got in the last rate-hike cycle that lasted from late 2015 to late 2018. The Fed began lowering rates by mid-2019, and then of course put rates into a deep freeze when the pandemic hit.
The Fed’s changed gears quite a bit coming out of the coronavirus crisis, and it could have an impact on how we look at the dot plot. Fed Chairman Jerome Powell said in March 2021 that the Fed is going to let the employment and inflation data actually demonstrate improvement before taking any action on tightening monetary policy.
In the past, the Fed often tried to fend off recession or overheating ahead of time by making policy moves that tried to anticipate those metrics. Not any more. That could mean the dot plot has a little less relevance, at least for a while. After all, if the Fed loudly declares it’s doing nothing for several years, maybe the projections are just dots on paper.
The Fed seems locked in and could be a for a while as it keeps the focus more on improved employment. Basically, there’s a much longer inflation runway these days, so those dots may not change as much in the near term. Instead, focus could center more around the Fed’s $120 billion a month in bond buying. Powell assured investors they’ll get plenty of warning ahead of any “tapering” of this monetary support, so that might supersede the dot plot (for now) as a first sign of any change in Fed psychology.
Remember when you gaze at those dots on the afternoon of an FOMC meeting that a lot can happen between that time and the next dot plot. As newspaper writers were often reminded back in the day, today’s news can become tomorrow’s fish wrapper.
The best way to tell if there’s a potential surprise brewing in the next dot plot is to watch the market over the two weeks leading up to the FOMC meeting, Coffey noted. Keeping track of the CME FedWatch tool on a daily basis is another way to consider keeping up with market expectations.
Meanwhile, any equity investor with a long-term horizon might want to focus on good, solid companies, while understanding the impact that Fed moves can have on specific industries. Rising rates often favor banking, but not housing, Coffey said. Lower rates tend to favor the Real Estate sector, as well as sectors that typically offer higher dividends, like Utilities and Consumer Staples.
Like the dot-to-dot puzzles from your childhood, connecting the dots can be an essential first step in assessing the full picture.
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