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”

Bloomberg Businessweek (Asia) - - CONTENT - −Craig Tor­res The bot­tom line Mar­kets have no­ticed that Fed­eral Re­serve of­fi­cials' in­ter­est rate fore­casts aren't ter­ri­bly ac­cu­rate.

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,

The Pre­dic­tors

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.”

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