Do You Dot Plot? Understanding the Next Fed Forecast

It’s probably the most closely scrutinized scatter chart in world financial markets. Every three months since January 2012, the Federal Reserve has sent analysts scurrying by updating its “dot plot,” which has become the de facto monetary policy forecast of the U.S. central bank — whether the Fed wants it to be or not. It’s also an important source of clues to dissent within the Fed’s policy-making committee, even if it can be as cryptic as it is crucial.

1. What is plotted on the dot plot?

It’s a chart showing estimates of what the federal funds rate, the short-term interest rate controlled by the Fed, should be. Members of the rate-setting Federal Open Market Committee each assign a dot for what they view as the midpoint of the rate’s appropriate range at the end of each of the next three years and over the longer run. Investors focus on the median dot. As many as 19 monetary policy makers — the seven governors on the Fed Board in Washington and the presidents of the 12 regional banks — can contribute a dot.

2. What good is a projection of the fed funds rate?

The dot plot was invented in late 2011, at a time when Fed officials were considering how to prepare markets for the shift they hoped to make away from the unprecedented array of monetary support measures they’d put in place after the financial crisis. The Fed chairman at the time, Ben Bernanke, and Janet Yellen, who served as Bernanke’s deputy before a four-year stint as chair, saw the dot plot as a way of giving markets a look into the Fed’s thinking beyond any immediate decision-making. FOMC statements focus mainly on current economic conditions and the immediate interest-rate target, though they’d evolved somewhat since the crisis and by December 2011 were offering investors forward guidance that rates would be held exceptionally low “at least through mid-2013.”

3. Why does it matter?

When the dot plot shifts, it can send a powerful message to investors on whether the U.S. central bank expects to speed up or slow down its planned tightening of monetary policy. It also creates a benchmark that can be used to highlight differences between the Fed’s official view and that of the financial markets. The central bank has been consistently more upbeat about its ability to lift inflation and, therefore, interest rates, than investors, though that gap narrowed during 2017 as economic growth picked up.

4. Can I tell which Fed official offered which dot?

No. The dot plot carries no names, so there’s no way to tell, say, which estimate was offered by the Fed chair (though analysts have their suspicions). The anonymous nature of the dot plot is one reason it has critics as well as fans.

5. What else do dot plot detractors say?

Maybe the biggest beefs are that the projections don’t reflect a commitment by the FOMC to act and aren’t an official consensus forecast. (Fed staff explored hammering out a consensus dot, but officials decided that it would be too hard to get agreement among so many officials with such disparate views.) Each individual member may base his or her forecast on a different economic model or set of assumptions, which means there’s no consistency in how the dots are generated and no sense of the thinking behind them. Further complicating things, of the 12 regional Fed presidents, only five are voting members of the FOMC in any given year. That raises questions over how well the dots accurately reflect longer-term FOMC intentions.

6. How do Fed leaders view the dot plot?

With mixed feelings. In 2014, at her first FOMC press conference as chair, Yellen said people “should not look to the dot plot” as “the primary way in which the committee wants to or is speaking about policy to the public at large.” But in 2016, after Fed officials had trimmed their forecast for the number of rate hikes that year to two from four, Yellen told reporters that the shift in dots “largely reflects a somewhat slower projected path for global growth” and a tightening in credit conditions. Jerome Powell, who took over from Yellen as chair in February 2018, said in December 2018 that the dot plot “generally does provide useful information.” In a speech in March 2019, he said the dot plot “has, on occasion, been a source of confusion,” and he said he had asked an FOMC subcommittee “to explore ways in which we can more effectively communicate about the role of the rate projections.”

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