Definition:
The dot plot of the U.S. Federal Reserve is a chart that summarizes the Federal Open Market Committee (FOMC) members’ expectations for the federal funds rate. Each dot represents the expected interest rate from one of the committee’s 12 members.
How does the U.S. Federal Reserve dot plot work?
The committee consists of seven members from the Board of Governors of the Federal Reserve System and the president of the Federal Reserve Bank of New York. The remaining four seats are periodically filled by presidents of the other 11 Federal Reserve Banks. These presidents serve a one-year term. One president is selected from each of the following regional groups of Federal Reserve Banks: Boston, Philadelphia, Richmond, Chicago, Cleveland, Dallas, St. Louis, Atlanta, San Francisco, Kansas City, and Minneapolis.
Each dot on the chart represents one member’s view on what the interest rate should be at the end of the various years displayed, as well as in the long term. This long-term view represents the peak interest rate after the Fed has finished tightening policy from its current levels. The official interest rate expectations are determined based on the average of all the dots.
More important than the relative number of expectations is the direction of movement. Investors want to know whether the FOMC is leaning towards a more accommodative monetary policy (lowering rates) or a more hawkish stance (raising rates). For example, the shift towards higher rates in the chart in March 2014 led to a short-term drop in stocks and bonds, reflecting investors’ fears that the Fed might raise rates sooner than expected.
What the U.S. Federal Reserve dot plot is not?
When looking at the chart, it’s important to remember that each dot represents a member’s view on the range of interest rates at that time. The dot is in the middle of the range. In other words, the dots should not be understood as representing the member targeting that specific number.
It is also important to remember that the Fed relies on data and adjusts its policy based on economic trends, inflation, and global events. In the case of significant developments, such as a terrorist attack, a sharp economic downturn, or a sudden spike in inflation, the latest dot plot may not reflect the members’ expectations. Thus, the long-term expectations in the plot carry less weight than those closer to the present. Changes in the leadership of the Fed — with terms ending, resignations, and new appointments to fill vacancies — increase the likelihood of changes in long-term policy.
Furthermore, there is no way to know which dot belongs to which member, so investors have no sense of how significant the unusual dots are. It cannot be known which dot belonged to Jerome Powell, the Fed chair in 2019, and which dot belonged to a Fed president who is no longer a member of the committee.
Naturally, this won’t stop market participants from reading a lot into the specific relative averages created from each new release of the Federal Reserve dot plot. Bond investors should expect this release to be a new source of market volatility after every Fed meeting. However, former Fed Chair Janet Yellen warned that people “should not look at the dot plot as a primary means of communication by the committee to the general public.”
Source: https://www.thebalancemoney.com/what-is-the-fed-dot-plot-416891
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