Of all the maddening things about this month’s Federal Open Market Committee meeting, perhaps the single most annoying is the hoopla surrounding the so-called dot plot. It even has its own Twitter hashtag: #Dotplot.
The dot plot is a chart that shows the expectations of each FOMC member — absent their names — for where they believe the central bank’s overnight lending rate will be in the future.
Here’s a recent example:
Source: Federal Reserve
That there were four members of the FOMC who thought at the end of 2014 that Fed rates would be at 2 percent by 2015 is, well, kind of adorable. Deeply misguided, totally wrong, but still cute in a wonky way.
The problem with this dot-plot chart is that it reflects a three-factor forecast:
— Each FOMC member’s expectations of the state of the economy in both the near and distant future.
— How each member believes they will vote on rates in light of that future economy.
— And what the consensus of the FOMC will be on rates in the future.
I have a slightly different view. A Fed official (or Treasury Secretary or President) can usually not come out and say the likely truth about an economic or monetary turning point because their mere utterances can become a self-fulfilling prophecy. If the Fed Chairman announces that the country is going into recession, it is likely that the country would go into a recession (if it is in a precarious state) just because people will act on that utterance. So they can only publicly recognize a state like that when it is obvious it is actually going on.
For interest rates, the big fear is that the Fed will mistime something. If people think the Fed is far too dovish, then elevated inflation expectations could cause long bond yields to rise which would not be what they would want right now. So having a few dots indicating that they think the Fed funds rate will be 2% at the end of 2015 is a good way of signaling “We are on it” with regards to potential rapid action to combat inflation without actually having to do anything at all. It also indicates they believe the economy is strengthening significantly which is also confidence boosting.
If they all predicted less than 0.5% at the end of 2015, you can bet that the headlines would be “Fed unwilling to combat inflation” or “Fed believes the economy still sucks”, neither of which are confidence boosting.
So you are saying that we have to read between the dots.
Or you just pay attention to what they do instead of what they say.
Now the big buzz for the next meeting will be about when the Fed is getting to be “impatient” since Yellen introduced that word in her oratory from the pulpit today.
I still find it hard to believe we will see a Fed Funds increase while the US dollar is following a Saturn 5 trajectory.