Much like air traffic controllers seeking to piece together where the incoming flights are and where they are headed, financial market participants have taken to scrutinising the ‘Fed dot plot’ that is part of the Federal Reserve’s package of ‘projections materials’ for clues on the course of US monetary policy and the extent of the consensus within the policy-setting Federal Open Market Committee (FOMC).
The chart, showing where each of the FOMC members think the main federal funds rate will be at the end of the year for the next few years and in the longer run, has been released every quarter since January 2012 to offer investors ‘forward guidance’ and improve monetary policy transparency. The aim is to prevent investors being caught off guard about policy intentions (which can be particularly important when policy rates are at or near zero, as they are now).
The Fed dot plot does shift
The latest Fed dot plot (see below) showed a notable shift in the stance of the FOMC. When the Fed raised its benchmark rate last December to 0.25% to 0.50%, officials had expected to push rates up by a further percentage point in 2016.
Exhibit 1: FOMC participants’ assessments of appropriate monetary policy as of 17 December 2016
Source: Bloomberg, 4 April 2016
But at the 15-16 March policy meeting, they scaled back that plan to a half-point increase, expecting headwinds to economic growth to subside only slowly and not wanting to appear to be in a rush to push US interest rates higher. Several meeting participants felt a cautious approach to raising rates would be prudent or noted that a sense of urgency was appropriate now.
Exhibit 2: FOMC participants’ assessments of appropriate monetary policy as of 16 March 2016: midpoint of target range or target level for the federal funds rate
Source: Bloomberg, 4 April 2016
Scrapping doves and hawks
Financial markets welcomed the more lenient position and dovish tone from the Fed, giving the US dollar a leg-up and easing market concerns about a growing disconnect between central banks ready to start policy tightening as their economies recover and other monetary policy authorities eager to maintain or expand a loose policy to encourage economic growth and inflation.
In the hawkish camp, some regional Fed presidents have since argued that there is sufficient growth momentum to justify a rate increase as early as this month, pointing to a strong labour market. However, given the absence of wage pressures – a factor that could drive inflation higher – and the abundance of disinflationary forces from abroad (e.g. overcapacity in China), it looks like a tightening move will not come before June, to be followed by only one more 25bp increase later in the year. Such a scenario would match the latest FOMC projections.
Fed chair sets the tone
Countering the hawks, Fed chair Janet Yellen took control of the debate in a recent – dovish – speech, making it clear that she wants to see more stable global financial markets and commodity prices, that she does not want the US dollar to become too strong and signalling thus that she is not in favour of an early rate hike (see also A distinctly dovish tone from Janet Yellen).
It is worth noting that the Fed dot plot cannot be seen as an immutable roadmap of where policy rates are headed. It simply shows the results of a survey of each member’s best ‘guesstimate’ of what the fed funds rate will be in the coming years. Events may well lead to changed views. FOMC members are of course human and therefore struggle with predicting the future as much as the rest of us do. So their views are best taken with a pinch of salt. Since the dot plot was introduced, the FOMC has been consistently over-optimistic in predicting how it will set the fed funds rate. [divider] [/divider]
See also Chart of the week – a new dot plot from the Federal Reserve (28/09/2015)