The Federal Reserve’s rate path “dot plot” has become increasingly detached from financial markets’ interest-rate projections and risks sending an overly hawkish message that may undermine the central bank’s credibility.
Despite falling inflation expectations and turmoil in financial markets this week as concerns about growth mounted, the Fed hewed to its message that it could build on December’s rate rise with further hikes in 2016.
Quite how many rises is unclear, and there is just one tool economists can use to get an idea: a chart in the Fed’s quarterly “Summary of Economic Projections” known colloquially as the dot plot. The chart shows individual Federal Reserve rate setters’ expectations, although they are not identified by name.
Both Fed Chair Janet Yellen and New York Fed Chief William Dudley suggested this week that rate rises were still on the cards, pointing to the underlying health of the U.S. economy.
Neither referred directly to the “dot plot” that envisages four rate hikes this year, versus market pricing of a one in three chance of even a single rate rise this year. Fed officials say that while the dots, issued every quarter, do not represent a rate path per se, they can be used to manage expectations.
“Part of the problem is that it is consistently wrong,” said Tim Duy, an economics professor at the University of Oregon. “The second part of the problem is that the Fed doesn’t seem to recognize how terrible their forecasts have been.”
Fed officials have had to regularly ratchet down their dot-plot forecasts since they began publishing them four years ago. At the time the Fed said the publication of individual rate forecasts would give markets a better idea of where the Fed was heading. Economists say it was a useful signaling tool to reinforce the bank’s commitment to zero rates.
“I think they have outlived their usefulness and they risk sending a signal that (Fed officials) have a ‘plan’ rather than that they are data dependent,” said JP Morgan economist Michael Feroli.
Prior to Yellen’s appearance this week in Congress, she had not spoken since signing off on the December rate rise. She has no listed speaking engagements until the March Federal Open Markets Committee meeting – a gathering the Fed had wanted to keep on the cards for a potential rate rise.