HSBC: The Fed's Dot Plot Is Destructively Deceptive
The Federal Reserve's economic forecasts and much discussed dot plot might be a source of more confusion than clarity, according to HSBC Strategist Lawrence Dyer.
The central bank's Summary of Economic Projections haven't proven too accurate -- but that's not the primary basis of his gripe. Rather, Dyer has a more fundamental qualm with the assumptions underlying the construction of the numbers as well as how they are interpreted and reported.
"Mark Twain’s description of the three types of lies may be of use to bond investors looking to interpret the FOMC’s rate guidance – statistics can deceive," quipped the strategist.
Dyer's colleague at HSBC, Global Head of Fixed Income Research Steven Major, has the most bullish view on bonds among analysts surveyed by Bloomberg, calling for the yield on the benchmark U.S. 10-year Treasury to end 2016 at 1.5 percent.
This outlook for rates is predicated on the notion that analysts' calls for where the 10-year yield will go are too anchored to the Fed's forecasts for its policy rate. That is, even though the central bank's dot plot has consistently moved closer to the Eurodollar futures curve as time as passed, survey-based expectations for the initiation and pace of the tightening phase and the subsequent effect on rates further out the curve are being skewed higher by the glide path for rates outlined by monetary policymakers, according to Dyer.
Everybody on the Federal Open Market Committee -- from the (presumably) negative-dotted Narayana Kocherlakota to the hawkish Jeffrey Lacker -- sees the Fed raising interest rates to a level that's roughly consistent with monetary policymakers' opinions of where the federal funds rate should be in the long term by 2018.
These dots assume that unemployment, economic growth, and inflation will unfold in-line with a given FOMC member's projection. And embedded in these forecasts is universal agreement among monetary policymakers that the business cycle will not turn by this time, the strategist notes, and a downturn is an outcome that would be supportive of Treasuries.
"This seems to downplay the bearish risks to their forecasts, in our view," wrote Dyer. "There have been four recessions since the early 1980s and none was predicted by the Fed, for example."
In addition, the press' treatment of the median of these 17 dots as indicative of the consensus view among FOMC members or the most likely outcome for short-term rates irks the strategist. Since the Fed has perennially overestimated how high the federal funds rate would be at the end of a given period, he contends that the risks to the median forecasts turning into the eventual outcome are biased to the downside.
"The focus on the median dot effectively puts 100 percent of the probability distribution on the 2.65 percent median," according to Dyer. "Investors should weigh the probabilities of a wider range of rate outcomes to correctly price securities."
And not all dots are equal, he adds -- that of Fed Char Janet Yellen's certainly carries the most sway.
Dyer then did some mathematical gymnastics with the results of the New York Fed's surveys of primary dealers and market participants to account for the alleged anchoring. He found that the futures market's implied federal funds rate of 1.15 percent at the end of 2017 is roughly in line with the midpoint of the adjusted survey-based results -- which assign even odds to the Federal Reserve initiating liftoff in December or refraining from hiking rates for two additional quarters. That's a number of hikes shy of the 2.65 percent federal funds rate implied by the median Fed dot.
"You can form your own view on the likely distribution of the future funds rate," Dyer concludes. "We may all agree that investors should not have to run through this amount of statistics and survey design issues."