The Chart That Explains the Fed's Thinking Behind the Next Rate Rise

Fed Chair Janet Yellen's News Conference in Two Minutes

Chair Janet Yellen has found an unusual pacifier for financial markets anxious for clues about the Federal Reserve’s intentions: a chart with 68 blue dots.

The dots represent Fed officials’ forecasts for their main interest rate over the next three years. At her press conference this week, Yellen deployed them to emphasize her message that policy will remain easy for “quite some time” after the Fed raises rates above zero.

The chart shows the FOMC's dot plot, overlayed with blue lines illustrating how the median official's fed funds rate projection for the end of each year has evolved over the last three quarters, and a red line showing current market pricing of the future path of rates.
The chart shows the FOMC's dot plot, overlayed with blue lines illustrating how the median official's fed funds rate projection for the end of each year has evolved over the last three quarters, and a red line showing current market pricing of the future path of rates.

Investors took note.

Stocks rallied after the so-called “dot plot” showed more Fed officials projecting just one rate rise this year, instead of two or more, and slower increases thereafter. Some observers, including Jan Hatzius at Goldman Sachs Group Inc., assume that Yellen herself is among those who see just one move in 2015 -- even though the forecasts are all anonymous and the median estimate continued to call for two moves.

The dots have taken on added significance since March, when the Fed dropped longstanding, explicit assurances that rates would remain low. Now, the dots provide a key clue on the likely timing of the first rate rise since 2006, and the pace of increases to follow.

“The dots are a form of guidance,” said Roberto Perli, a former Fed board economist who is now a partner at Cornerstone Macro LLC in Washington. “That’s the best way we have to tell what different people are thinking.”

Yellen’s emphasis on the dots marks a shift from the position she took during her first press conference as Fed chair in March 2014, when she told reporters “one should not look to the dot plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large.”

Lean Against

Now, the interest-rate projections allow the Fed to lean against adverse movements in financial markets that could undermine the economic expansion.

The dots are arguably a more flexible communication tool than the time-based guidance the Fed removed from its policy statement in March, when it dropped a promise to be “patient” on raising rates.

That’s because they incorporate assumptions about growth, unemployment, and inflation, and can be altered in response to incoming data, said Robert Eisenbeis, chief monetary economist at Cumberland Advisors in Sarasota, Florida and a former Atlanta Fed research director.

“There is all sorts of optionality built into them,” Eisenbeis said. “They will change the forecasts as the data changes.”

In June, officials projected the benchmark federal funds rate will rise to 2.875 percent by the end of 2017, according to their median forecast. That is down from 3.125 percent in March. In December, the median was 3.625 percent.

In-House Simulations

The downgrades are consistent with simulations using the Fed’s in-house macroeconomic model, known as FRB/US, according to Lewis Alexander, chief economist at Nomura Securities International Inc. in New York.

Between December and March, a swift appreciation in the dollar helped bring growth to a standstill. Since the FOMC’s March meeting, the dollar’s climb has been curbed, but a sharp rise in long-term interest rates prompted another dot downgrade, said Alexander, a former Fed economist.

“Financial conditions are an important part of their outlook,” he said. “As they move, and they have a clear effect on the outlook, that is going to be reflected in the projected path of rates.”

Yield Spike

Yields on 10-year Treasury notes are up 0.41 percentage point to 2.33 percent since the March meeting, raising the cost of borrowing on everything from autos to houses.

The forecasts released Wednesday showed seven officials project fewer than two rate increases in 2015, up from three officials in March.

Goldman Sachs economists revised their forecast for the timing of a rate increase to December from September, based on their assumptions about where Yellen’s dot now lies.

“While we cannot be certain, our best guess is that Fed Chair Yellen now anticipates only one increase this year -- an important shift in the committee’s center of gravity,” Hatzius and his colleague Zach Pandl wrote in a note to clients.

As evidence, they cite dovish remarks Yellen made during her Wednesday press conference, including a comment that “an increase this year is possible” as opposed to probable.

Traders in the market for futures contracts tied to the federal funds rate also seemed to take a cue from the lowest projections, recalibrating the likely timing of liftoff to December from October, according to data compiled by Bloomberg.

The next set of forecasts won’t be published until September, and data between now and then could convince more officials that two rate increases are warranted this year, said Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York.

“If the economy strengthens, you could see the dots move up,” Dutta said.

For more, read this QuickTake: Forward Guidance

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