The Fed posts a chart, then wishes markets wouldn’t take it so seriously
The Fed wants markets to pay less attention to its own rate forecasts “I’ve even thought about dropping out… from the whole exercise”
In January 2012 the Federal Reserve unveiled a new way to communicate its officials’ current thinking about the direction of interest rates. Each quarter, members of the committee that sets the benchmark federal funds rate would provide anonymous forecasts of where it would go in the next few years. Each official’s predictions were represented by tiny dots on a chart that quickly became known as the “dot plot.” The idea was to make the Fed more transparent, but now some officials say the chart offers too much noise and not enough useful signals.
One problem: Since the forecasts come out only four times a year, they’re stale as soon as any new information about the economy and inflation comes along. What’s more, financial markets often disagree with the dot plot, exposing a potentially costly gap. Where investors think the Fed is going helps determine the rates on everything from government and corporate bonds to mortgages and car loans.
The dots “seldom add anything useful beyond the communication already presented by the Fed news conferences, the statement, speeches, and testimony,” says Jon Faust, director of the Center for Financial Economics at Johns Hopkins University in Baltimore and a former adviser on communications to Chair Janet Yellen. “We should have all learned that they don’t say where policy is going.”
In March 2015 the dots predicted the federal funds rate would end the year above 0.5 percent, suggesting the central bank would put in place two quarter-point rate hikes from near zero. There’s been only one.
Some market participants have clearly gotten the message. When Fed officials released a fresh forecast on Dec. 16, the median of their estimates signaled four rate hikes for 2016—a sign they saw the economy steadily improving, requiring higher rates to hold back inflation. Markets were much more cautious. Traders who use financial contracts to speculate on interest rate changes put only a 9 percent probability on the Fed following through, according to data compiled by Bloomberg.
On March 29, Yellen said new risks in the global economy meant officials would have to “proceed cautiously” with further rate hikes.
Dissatisfaction with the dots seems to be growing within the Fed. St. Louis Fed President James Bullard, a voting member of the policy-setting Federal Open Market Committee, says the rate projections contribute to uncertainty. “I’ve even thought about dropping out unilaterally from the whole exercise,” Bullard says.
Fed Vice Chairman Stanley Fischer is leading an internal subcommittee that’s trying to figure out ways to tell the public the dots are at best a guess in a moment in time. One proposal,
Each dot represents one FOMC member's forecast for yearend interest rates
revealed in the minutes of the Fed’s Jan. 26-27 meeting, is to bring in yet another shape: a fan.
A fan chart would show the range of uncertainty around a forecast, a band that would spread wider the further the forecast extends. (Hence the fan.) Another possibility discussed by academics and former Fed officials is to leave the dots as they are and focus instead on describing scenarios. There could be charts of how policymakers would respond to shocks and surprises.
This is what they’re trying to communicate all the time. According to transcripts of FOMC meetings, the committee’s staff already does this using a computer-generated scenario with a Fed funds rate path. “I like that idea better than a fan chart,” says Laura Rosner, U.S. economist at BNP Paribas in New York. Yellen, she says, “could walk us through the scenarios in her press conference and discuss how policy might respond.”
Although Johns Hopkins’s Faust favors retiring the dot plot, he says it still achieves two of the big goals of former Fed Chairman Ben Bernanke, who first instituted it. Bernanke wanted all of the FOMC members, not just the chair, to be seen as authorities on policy. And he wanted those members to be more accountable. The dots provide a hint of their views and of how diverse they are.
In March, for example, one member saw the federal funds rate going up to about 2 percent by 2018. Another member saw rates rising close to 4 percent. For her part, Yellen, in 2014 at her first news conference as chair, said the public “should not look to the dot plot” as the main way the Fed communicates. She said to look instead at the central bank’s official statement.
Of course, the dots may simply show the Fed has had too rosy a view about the pace of the economic recovery. “I always laughed at the dots,” says Karl Haeling, head of strategic debt distribution at Landesbank Baden-Württemberg in New York. “They have always been overly optimistic.”