The Federal Reserve’s dot plot explained — and what it says about interest rates

7 min read

When the Federal Reserve announces its next interest rate decision, you might want to hold off on connecting any dots.

That’s because U.S. central bankers are about to update their Summary of Economic Projections (SEP), as well their heavily scrutinized “dot plot” chart. This graphic indicates to consumers just how much each Fed official thinks it will cost to borrow money in the future.

But even though it seems comparable to getting a sneak peek at the winning lottery numbers, you should still proceed with caution. Many experts – including members of the Fed itself – are questioning the predictive power of this tool. Officials’ quarterly forecasts this year also didn’t predict the Fed’s ultimate direction.

“If you pay too close attention to the dots, then you may lose sight of the larger picture,” Federal Reserve Chairman Jerome Powell told journalists at a press conference following the Fed’s June 18-19 rate-setting meeting, referring to the forecast’s granular view of policy.

Taking those precautions could be even more important this time around. The Fed has cut rates three times this year to cushion the U.S. economy from downside risks. Fed officials have signaled that policy is in a good place and will likely stay that way, as long as their economic outlook stays the same. That means Fed officials are operating on a meeting-by-meeting basis, with forecasts anything but locked in.

Here’s everything you need to know about the dot plot, including what it is, how to read it – and why you might want to take it with a grain of salt when it’s updated.

What is the dot plot, and how do I read it?

The dot plot is a chart that records each Fed official’s forecast for the central bank’s key short-term interest rate, currently in a target range between 1.5 percent and 1.75 percent. (Fed officials are expected to leave it alone when their two-day meeting wraps up Wednesday in Washington).

Each dot represents one Fed official – from Powell to Governor Lael Brainard, from New York Fed President John Williams to St. Louis Fed President James Bullard. Of course, it’s all kept anonymous, and no one knows which official is which dot.

The dots reflect what each U.S. central banker thinks will be the appropriate midpoint of the fed funds rate at the end of each calendar year, should the economy evolve as they expect. Officials also provide a dot for three years into the future, as well as a dot for the longer run.

On the Y-axis is the fed funds rate, and on the X-axis is the year for which officials gave their forecast.

Federal Reserve's dot plot

By looking at the chart, you can identify where the clusters are, which in turn allows you to infer where the Fed’s bias may lie.

For example: You can tell that, as of September 2019, the median estimate among Fed officials predicted that the federal funds rate’s midpoint would lie at 1.875 percent by year end – reflecting two cuts total. Seven officials, however, penciled in one more reduction, bringing the fed funds rate down to 1.625 percent (That’s exactly what the U.S. central bank ended up doing).

You can also see eight officials expected the federal funds rate to hold at a midpoint of 1.625 percent in 2020, more than any other cluster.

Over the longer-run, also referred to as the neutral rate of interest that neither speeds up nor slows down the economy, officials expect the fed funds rate to be 2.5 percent.

It may sound daunting, but if you have a high-yield savings account or are carrying credit card debt, the chart offers clues about where rates might be a year or two from now, from the officials in charge of making those decisions.

But there are obvious caveats. Economists mainly look for the median forecast depicted in the chart. And that forecast showed a federal funds rate midpoint of 1.875 percent by the end of 2019 — reflecting just two cuts, instead of the three policymakers would eventually vote for. This shows that the dot plot was unable to predict the Fed’s course of policy just eight weeks into the future.

Why the dot plot was created

Fed officials created the dot plot in 2011, at a time when the economy was still recovering from the Great Recession and when interest rates were still near zero. The central bank wanted to give Fed watchers an advance look at what officials were thinking before they made any official policy decisions.

It was a form of “aggressive forward guidance,” a concept that former Chairman Ben Bernanke created to prepare markets for the Fed’s movement away from the unconventional support measures it introduced to keep the economy afloat, according to Ryan Sweet, director of real-time economics at Moody’s Analytics, who also heads its monetary policy research.

But the backdrop since introducing the dot plot has changed. The economy is in better shape now compared to a decade ago, with an unemployment rate near the lowest level since 1969 and an expansion that’s about to become the longest on record.

The outlook is becoming a lot more difficult to forecast, with trade tensions clouding the picture. There’s of course the chance that a deal with China could be reached. There’s also, however, the risk that the tensions could worsen, causing a devastating blow for the U.S. economy.

“You have to remember with the dot plot that this is, in many ways, officials’ base case scenario – if everything unfolds the way they expect,” says Sarah House, director and senior economist at Wells Fargo. “Trade assumptions are very important” to that outlook, “but more than anything, it’s changing very rapidly.”

Why you might not want to place too much focus on the dot plot

Fed officials have stressed since January that they’re going to be “data dependent.” At a time when the economy sends off some conflicting signals, officials mean they won’t have a predetermined path for interest rate adjustments.

Officials are also “closely monitoring” risks to the economic outlook, such as trade tensions, with Powell noting in previous instances that the Fed is willing to “act as appropriate to sustain the expansion.”

And now, the Fed feels comfortable after its three rate cuts. Policy is in a good place, Powell said during the Fed’s October press conference, and officials expect that to continue, so long as the U.S. economy doesn’t show signs of worsening.

But being highly reactionary means forecasts will likely change, suggesting that the dot plot might have a quick expiration date.

“To be more data dependent, the Fed needs a lot of flexibility,” Sweet says. “The dot plot isn’t a forecast. It’s not a commitment. Interest rate projections change as the economy changes, as developments in financial markets change. The dot plot gets dated pretty quickly.”

The uncertain backdrop diminishes the dot plot’s predictive power even more, according to Julia Coronado, president and founder of MacroPolicy Perspectives, who used to work for the Fed’s board of governors.

“In a slowdown, the SEP gets harder to manage,” Coronado says. “There’s nowhere in the SEP that they can express that uncertainty.”

There’s also the chance that it can be misinterpreted – or ignored. Wall Street panicked in December, after the Fed delivered a hawkish post-meeting statement that called for “further, gradual increases” and published a dot plot that mapped out two more increases in 2019.

Though Powell emphasized that the Fed’s policy decisions “are not on a preset course and will change if the incoming data materially change the outlook,” the meeting still helped send stocks to their worst December since the Great Depression.

The number of dots – normally at 19, but right now at 17 due to the two vacancies on the Fed’s board of governors – might mean it’s more noise than signal, says Jonathan Wright, professor of economics at Johns Hopkins University. There’s no telling how each leader arrives at his or her own forecast, and only 12 members have a vote on the Federal Open Market Committee (FOMC).

“You think more information is good, but you’ve got 19 people with very different models of the economy all simultaneously submitting their forecasts and not all of them vote on monetary policy, and they all appear,” he says. “Is that really conveying useful information? That’s very debatable. Some people think it just creates confusion or a mixed signal.”

Why the dot plot might soon be revamped (or eliminated)

Minutes from the Fed’s January meeting show that some officials are questioning the usefulness of the Fed’s dot plot.

“A few participants expressed concerns that in the current environment of increased uncertainty, the policy rate projections prepared as part of the Summary of Economic Projections do not accurately convey the Committee’s policy outlook,” records of that meeting said.

The Fed in June completed a review of its monetary policy framework and communication strategies, after which it could choose to alter – or get rid of – this projection tool. That likelihood, however, remains unclear. Though Powell said during the Fed’s June 19 news conference that it can lead to confusion, he also said the dot plot “can be a constructive element of comprehensive policy communication” if it’s properly understood.

A lot of people on the committee also like it because it gives the public a chance to see the full range of views. Regional presidents who don’t have a vote, for example, like that their input is still heard, Coronado says. And in an era of presidential backlash, the dot plot also increases transparency and trust in the institution, she says.

“The Fed feels like it really does need to explain and justify why it’s doing what it’s doing. The dot plot and the SEP is one element of a policy of transparency,” Coronado says. “But that doesn’t mean it’s useful for the public or for markets. It can be confusing, and it can be misleading.”

Updating those projections more than just once-a-quarter could improve the reliability of the chart, Sweet says, but so could taking it away and bringing it back during another downturn.

“Some approaches the Fed has taken are better than others, and given where we are in the cycle, we don’t need the dot plot right now. That doesn’t mean it can’t come back down the road,” Sweet says. “They’re normalizing the balance sheet, normalizing the interest rate, and they can kind of get back to normalizing their communication, getting it back to where it was before.”

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