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

GRAEME JENNINGS/POOL/AFP/GETTY IMAGES

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

That’s because U.S. central bankers at their March meeting will 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. It’s going to be notable because it’s the first time officials will be updating their projections since December 2021, and officials are expected to broadcast the most rapid tightening of monetary policy in decades.

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 — have questioned the predictive power of this tool. Fed officials’ projections are never set in stone, and they could continue to evolve as more information about the economy’s recovery comes in.

“Dots are to be taken with a big, big grain of salt,” Federal Reserve Chair Jerome Powell said at a June press conference. “They’re not a committee forecast, they’re not a plan. The dots are not a great forecaster of future rate moves. And that’s because it’s so highly uncertain.”

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 Fed’s dot plot?

The Fed’s dot plot is a chart that records each Fed official’s projection for the central bank’s key short-term interest rate. 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 three years into the future, should the economy evolve as they expect. Officials also provide a dot for the longer run, which represents the so-called “neutral rate of interest,” or the point where rates are neither stimulating nor restricting economic growth.

Each dot represents one Fed official — from Powell to board member Lael Brainard, from New York Fed President John Williams to Chicago Fed President Charles Evans. Of course, it’s all kept anonymous, and no one knows which official is which dot.

Still, three vacancies on the Fed’s board of governors mean there’s three fewer dots than there should be. One dot is also missing from the Fed’s longer-run projections: St. Louis Fed President Jim Bullard, who has been vocal about wanting to omit his projections.

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

Courtesy of Federal Reserve Board of Governors

How to read the Fed’s dot plot

The dot plot is helpful because you can spot the biggest rate clusters, which in turn allows you to infer where the Fed’s bias may lie. For example: You can tell that, as of December 2021, every official sees at least one rate hike. The biggest grouping of Fed officials — 10 policymakers — see three rate hikes, while five see two increases and two officials see four.

Over the longer-run, officials expect the fed funds rate to be 2.5 percent. That rate typically stays the same, but it could change over time as officials update their forecasts for inflation, unemployment and growth.

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: The future never evolves as the Fed expects. Case in point: The Fed at the end of 2019 broadly expected to hold rates steady in 2020 — until a nationwide pandemic brought the gears of the U.S. economy to a grinding halt. The Fed ended up slashing rates to near zero.

“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. “More than anything, it’s changing very rapidly.”

Why the dot plot was created

Fed officials started using the dot plot in 2012 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, recognizing that Fed communication can often be as powerful at guiding investors’ expectations as rate moves itself.

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.

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

The ultimate question isn’t so much whether rates are going to go up this year — but when, and how many times. Consumer prices over the past 12 months have skyrocketed, soaring in January to the highest level since February 1982.

Powell, for example, noted in a March congressional testimony that officials still see price pressures alleviating later this year as supply chain pressures ease. But he also stressed that officials are prepared to move even more aggressively — perhaps raising rates by half a percentage point at multiple meetings — if inflation doesn’t eventually come down.

Powell’s hope for rate flexibility suggests the Fed’s dot plot might not be useful this time around. Being highly reactionary means forecasts will likely change, possibly meaning each dot has 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.”

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.

Even Fed officials have questioned just how helpful the Fed’s dot plot can really be.

“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 the Fed’s January 2019 meeting said.

Though Powell has often said the chart leads to confusion, he also said in a March 2019 address that it “can be a constructive element of comprehensive policy communication” if it’s properly understood.

The dot plot increases transparency over Fed operations, according to Julia Coronado, president and founder of MacroPolicy Perspectives, who used to work for the Fed’s board of governors.

“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.”

The public also has a chance to see the full range of views on the Federal Open Market Committee (FOMC). Regional presidents who don’t have a vote, for example, can still input their rate projections. But that can often mean there’s more noise than signal since there’s no telling how each leader arrived at his or her own forecast, and only 12 members have a vote.

“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,” says Jonathan Wright, professor of economics at Johns Hopkins University. “Is that really conveying useful information? That’s very debatable. Some people think it just creates confusion or a mixed signal.”

Learn more: