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 among the information the Fed publishes after each meeting of the 16-member Federal Open Market Committee (FOMC), the central bank’s policy-setting arm.
Each dot represents an FOMC member’s view (anonymous views, by the way; no dots are “identified”) on where the benchmark fed funds rate should be at the end of the current year, plus a few years down the road.
Market professionals scrutinize the dot plots closely for clues about the Fed’s next moves on interest rates and its longer-term outlook on the economy, says JJ Kinahan, Chief Market Strategist at TD Ameritrade. While the central bank is subject to frequent criticism, “Fed people are pretty smart, so you should pay attention to what they’re telling us,” Kinahan says.
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.
Higher Rates Seen Possible By End of Year
Based on the latest dot plot, released last week after the FOMC’s most-recent policy meeting, the third fed funds rate hike of 2017 is likely to happen by the end of the year, market professionals say.
Eleven of 15 dots for 2017 are lined up just below 1.5% (each dot indicates the value, rounded to the nearest 1/8 percentage point, of an individual’s judgment for the midpoint of the fed funds target range). That suggests most FOMC members — around 70%—expect to raise the funds target range by 0.25% at their next meeting in December. The fed funds’ target is currently 1% to 1.25%.
“The probability of a hike in December is very high,” Kinahan says. “A December rate hike seems to be getting more and more built into the market.” If the probability of a rate hike is 70% or higher, “It almost always happens,” he adds.
Looking ahead, the latest dot plot indicates gradually rising rates through 2020 and beyond. FOMC members’ median target for the fed funds rate climbs to 2.1% at the end of 2018, 2.7% at the end of 2019, and 2.9% at the end of 2020.
Dynamics Beginning to Shift in Dot Patterns
More recently, Kinahan says, there appear to be some changes in dot plot patterns that indicate a shift in the dynamic between the Fed and market benchmarks, such as Treasury yields.
In the past, the dots were moving toward the expectations of market participants. More recently, market expectations appear to have moved toward the dots, as continued growth in the U.S. economy strengthened the prospect for higher rates. “The market does a good job of building these expectations in,” Kinahan says.
Still, December is a long time away as far as the market goes, and a lot can happen over the next few months, Kinahan notes.
“You really want to watch in the two weeks leading up to the December meeting” for potential surprises, he says.
Meanwhile, the equity investor with a long-term horizon might be prudent to focus on good, solid companies, while understanding the impact that Fed moves and higher rates can have on specific industries. Rising rates often favor banking, but not housing, Kinahan notes.
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