'Dot Plot' Fed Projections Lose Credibility With Pimco and BlackRock

Making Sense of the Federal Reserve's 'Dot Plot'
  • Treasury market is reacting less to interest-rate forecasts
  • Officials are often `cheerleaders' for economy, Aberdeen says

For the past four years, bond traders have quickly turned their focus after Federal Reserve meetings to something called the dot plot. A compilation of all 17 policy makers’ predictions on where they’ll take the benchmark rate (scattered in the form of dots on a chart), it was seen as a key insight into their collective thinking.

The problem is that the forecasts weren’t very good. Fed policy makers consistently overestimated the future strength of the U.S. economy and the pace of interest-rate increases, and traders are starting to tune them out. Market reaction to changes in the dot plot, once pronounced, has become more muted in recent months and investors at firms including Pacific Investment Management Co., BlackRock Inc. and Aberdeen Asset Management say they won’t take the Fed’s projections at face value when they’re updated Wednesday at the end of a two-day policy meeting.

“We don’t put a lot of credibility in the dots,” said Pat Maldari, senior strategist for fixed-income portfolios in New York at Aberdeen. Officials “have usually been cheerleaders for the economy, and they get turning points in the economy wrong.”

Curiously, this lost credibility may in a way prove helpful for the Fed.

When the dot plot was first released back in 2012, in an effort to give investors an idea of when the Fed may eventually raise rates, interest-rate moves were just a glimmer on the horizon. Now that the tightening cycle has begun -- back in December with a quarter-point increase in the benchmark rate -- the forecasts take on a different, more immediate feel. Having traders take their predictions too seriously could fuel unwanted expectations on rate decisions. That is why, some analysts say, a subtle shift is under way at the Fed to get the market more focused on actual economic data rather than on the dot plot.

“Time-based guidance is a blunt instrument,” said Jeffrey Rosenberg, New York-based chief investment strategist for fixed income at BlackRock. “One of the ways to describe the shift is, we’re no longer in a time-based guidance regime, and that introduces a lot more ambiguity around the market’s understanding of the policy path.”

Fed spokesman David Skidmore declined to comment.

Waning Influence

If the Fed is aiming to prepare the market for three or four rate increases this year, after officials in December projected four, traders aren’t buying it.

“We always thought four hikes was an aspiration, not a forecast” for this year, said Richard Clarida, New York-based global strategic adviser with Pimco. “If you ask me, ‘Rich, would you like to play third base for the Yankees,’ I say yes. If you ask ‘Rich, will you play third base for the Yankees,’ I say no.”

Shifting the bond market’s focus away from time-sensitive projections and more toward economic data would follow a recommendation from economists at a February policy forum.

Officials discussed allowing for more uncertainty in their dot-plot projections in January, according to minutes from the meeting, with “a fan chart to illustrate the uncertainty surrounding the path of the policy interest rate” in their statements. They decided to continue to investigate the possibility.

The waning influence of the Fed’s projections is showing up in derivatives markets. After the December revision to the projected path of interest rates, traders responded less than they did earlier in the year in the market for securities known as overnight-indexed swaps.

Aberdeen’s Maldari said he started questioning the economic projections in Fed statements in July, when the central bank inadvertently released confidential staff economic projections that implied rates should rise to 0.35 percent by the end of 2015, rather than the 0.625 percent implied in the most recent dot plot at that time.

“That tells me they are thinking one thing and saying something else,” he said.

Fed Meeting

Either way, as investors prepare for the Fed’s March 15-16 meeting, they think the policy statement and Fed Chair Janet Yellen’s press conference will attract most of the market’s attention. Clarida, of Pimco, expects the median Fed official’s projection will be for three interest-rate increases this year.

“Almost certainly, the 2016 dots will shift down,” Clarida said. But “if they mark down 2016 to one hike, that would be a surprise. It would also be negative for stocks and credit spreads,” since investors would take that as a sign the economy is weaker than expected.

While bond and derivatives prices indicate traders have moved slightly more in line with officials’ rate estimates, Clarida says the market still isn’t prepared for the Fed to raise rates two or three times this year, which he predicts. Derivatives markets are now pricing in about one interest-rate increase this year, according to data compiled by Bloomberg.

“Our view is, the market is too bearish,” said Clarida. “The market’s view will need to reflect at least” two hikes.

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