Learn About the U.S. Federal Reserve Dot Plot
U.S. Federal Reserve policy is critical to all of the global financial markets, so any insight into what the Fed is thinking always gains a great deal of attention from investors. That’s why the Fed “dot plot” has become one of the most-watched news releases during the course of the past year.
The dot plot, which is published after each Fed meeting, shows the projections of the 16 members of the Federal Open Market Committee (the rate-setting body within the Fed).
Each dot represents a member’s view on where the fed funds rate should be at the end of the various calendar years shown, as well as the “long run” – the peak for the fed funds rate once the Fed has finished tightening (or “normalizing” ) policy from its current ultra-low levels.
The dot plot represents the Fed’s ongoing efforts to become more transparent with respect to its policies. Currently, the members' average expectation is for rates to hit 1.27% at the end of 2015, 2.68% in 2016, 3.54% in 2017, and 3.79% in the long run. The current target for the fed funds rate is 0 - 0.25%.
More important than the absolute number for FOMC members’ projections is the direction of movement. In short, investors want to know whether the FOMC is leaning toward looser monetary policy (reducing rates) or tighter policy (raising rates). In March, for instance, a shift toward higher rates in the dot plot led to a short-term sell-off in both stocks and bonds – a reflection of investors’ fear that the Fed may raise rates sooner than expected.
What the Dot Plot Isn’t
When looking at the chart, keep in mind that each dot represents a member’s view of the range where rates should be at that time, with their dot in the center of the range. In other words, the dots shouldn’t be taken to represent that a member is targeting that specific number.
It’s also important to remember that the Fed remains data dependent, adjusting its policy based on economic trends, inflation, and global events. In the event of major developments such as a terrorist attack, a severe economic downturn, a sharp jump in inflation, etc., the members will shift projections from their current level. As a result, the longer-term projections on the dot plot carry less weight than those closer to the present.
Finally, it’s necessary not to lose sight of the fact that the FOMC membership changes and rotates among the various member banks in the system. In other words, the people behind the dots can change – another potential source of shifts in the dot plot. Not only that, but there is currently no way to tell which dot belongs to which member. Investors, therefore, don’t have a sense of how much weight to attach to a dot that is an outlier with the range for a certain period, nor is there any indication which dot belongs to Fed Chair Janet Yellen.
Naturally, this won’t stop market participants from reading a great deal into the specific averages that are generated by each new iteration of the dot plot. Bond investors should, therefore, expect that this release will be a new source of market volatility after each Fed meeting, joining the language used in the Fed statement the comments issued by Janet Yellen in her post-meeting press conferences.
However, Yellen herself warned that people “should not look at the dot plot as the primary way in which the Committee is speaking to the public at large.”
The bottom line: consider the dot plot one more tool you can use to make investment decisions, but – as is the case with any single indicator – be careful not to read too much into it.