Friday, 30 October 2020

Connecting the Dots: Understanding the Fed Dot Plot

Connecting the Dots: Understanding the Fed Dot Plot
31 Jul
7:09

Speculating about whether the Federal Open Market Committee (FOMC) might change interest rates is a time-honored tradition ahead of each Fed meeting. Luckily, the FOMC periodically publishes a special chart to give people more insight into the committee’s thinking about monetary policy. It’s called the Fed dot plot, and understanding how it works is key to grasping the Fed’s view on future rates.

The FOMC adjusts monetary policy according to the health of the U.S. economy, either hiking or cutting the federal funds rate to slow down an overheating economy or prop up flagging economic activity. Since the policy changes enacted by the FOMC affect almost every aspect of our financial lives, it helps to know what changes might be in store in the future. That way, you can better plan for things like lower mortgage rates or higher savings account rates.

What is the Fed dot plot?

First implemented in 2012, the Fed dot plot is a simple chart that illustrates each FOMC member’s prediction for the federal funds rate over the next three years, plus a longer-run outlook. Each Fed member anonymously indicates their own midpoint of target range for where the federal funds rate will be at the end of each of the next three years. Each member’s dot reflects their own idea of the appropriate policy path to take in order to help economic activity and maintain inflation around the Fed’s 2% target.

The Fed dot plot increases monetary policy transparency for the public, providing a quick, user-friendly look at the future target range of the federal funds rate. Furthermore, it also provides some insight as to where Fed members think the economy as a whole might be going in the coming years.

The Fed dot plot is included in the Fed’s Summary of Economic Projections (SEP), which is released after every other Fed meeting.

How to read the Fed dot plot

Take a look at the Fed’s most recent dot plot below, released after its June meeting. Eight members — one dot for each FOMC member — indicated that by the end of 2019, the federal funds rate would remain within its current target range of 2.25-2.50%. Another eight members, however, indicated their midpoint or target level below the lower limit of 2.25%, suggesting these committee members see a rate cut happening this year. Seven of them see the rate midpoint below 2%, while one sees the midpoint between 2.25-2.00%. Note also that one very bullish committee member sees the rate midpoint above the current range at 2.50-2.75%.

The majority of dots for 2020 and 2021 remain in the same range, none ever dipping so far as 1.75%. On the other hand, we see some pushing for a higher target rate above 3%. Fed members seem to lean toward a higher-rate climate in 2021.

Past 2021, Fed members indicate a higher likelihood of a midpoint target range between 2.5% and 3.25%.

As mentioned above, the dots are anonymous. No member of the public knows which official’s opinion is related to any given dot.

How the dot plot relates to you

The dot plot may seem like just another helping of financial jargon, only useful for economists and financial experts. But the rate forecast represented in the Fed dot plot can help you determine how your own finances might be affected by the future Fed monetary policy decisions.

Let’s use June 2019’s dot plot above as an example. So far, speculation around the federal funds rate in 2019 has had both its ups and downs. Back in March, there weren’t any dots below 2.25%. At the time, many experts thought there was a chance for one, perhaps two, rate hikes this year.

Now, however, with eight members indicating a 2019 rate lower than 2.25%, there’s more chance of a Fed rate cut. A Fed rate cut means you’ll earn less interest from your savings accounts. It also means lower borrowing rates, too, which can help you if you have credit card debt or an adjustable-rate mortgage.

You can then look at the dot plot to gauge how high — or how stagnant — rates may be in the next couple of years.

How not to use the Fed dot plot

The Fed dot plot can help us speculate about future Fed rate policy. However, if 2019 has taught us anything, it’s that things can change from one day to the next. Global trade negotiations have fluctuated and one month’s data reports can negate the next month’s data.

Thanks to a myriad of factors, the chance of a July rate cut has increased significantly, more than the dot plot might have signaled just a month ago.

Plus, the dots are merely the most likely outcomes for the federal funds rate, according to individual Fed members. “They are not a forecast of the group,” Chair Jerome Powell asserted at the June meeting press conference. “They’re not discussed or debated at the meeting. They’re an input to policy more than an output of policy.”

“If you pay too close attention to the dots, then you may lose sight of the larger picture,” he concluded. Essentially, don’t take each Fed dot plot release as a promise. Use it as a guide to better inform your own speculations, while keeping an eye on other economic climate factors. That way, when actual policy changes do occur, you’ll be more prepared.

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Lauren Perez

Lauren Perez |

Lauren Perez is a writer at MagnifyMoney. You can email Lauren here

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