How Useful Are The Fed’s Upcoming Interest Rate Predictions?

The closely followed “dot plot” will likely shift next week when officials at the Federal Reserve meet to discuss interest rates. However, some experts are wondering if the rate expectations outlined in the graph send the wrong signals.

The Federal Open Markets Committee (FOMC) will release its quarterly Summary of Economic Projections (SEP) at the conclusion of its June 12 meeting. The predictions include the dot plot, which depicts anonymized predictions for the path of interest rates, and next week’s graph will likely show that officials expect fewer rate cuts this year than they projected in March.

The June graph is particularly anticipated, amid hopes it will provide some long-awaited context about what “higher for longer” actually means when it comes to interest rates. Fed officials have been vague on how long it may take for them to have confidence that inflation has subsided enough for them to consider cutting the benchmark fed funds rate, which is at a two-decade high and has driven up borrowing costs on everything from credit cards to home loans in the past year. 

However, some experts are raising questions about how useful the collection of dots truly is. Meanwhile, recent research shows the dot plot almost always leads market sentiment—often in the wrong direction.

Some Say Dot Plot Should Be Ditched

Issued four times a year, the dot plot is designed to set market expectations about where interest rates are going. But a recent survey by the Brookings Institute showed more than 40% of market participants said they believed that the Fed should do away with or change the dot plot.

Through the survey, Brookings identified major complaints about the dot plot from private sector and academic or think tank market watchers. The largest issue respondents reported is that the anonymous projections and aggregated medians paint a confusing picture of the path ahead.

Some Federal Reserve officials have raised similar concerns about the graph’s effectiveness. Outgoing Cleveland Federal Reserve Bank President Loretta Mester said in a recent address that the Fed should add more information about economic projections to “connect the dots.”

“Currently, the variables in the SEP are not linked across participants, and the median paths provided don’t necessarily represent a coherent forecast,” Mester said. “If we were to connect the dots to the forecasts within the SEP, the public would get a better sense of each individual policymaker’s reaction function.”

Her colleague, Chicago Fed President Austan Goolsbee, said that, without knowing the economic forecasts of each member, the dot plot served to focus attention on “how many” interest rate changes are expected.

“Without a connection of economic conditions to rate projections, the dot plot is just a collection of opinions without economic content,” Goolsbee said in remarks this month at Stanford University. “In times of heightened uncertainty or unusual risks, the policy playbook can be complicated and requires more than just dots.”

Fed Vice Chair Phillip N. Jefferson said he believed the dot plot is useful, but the public should remember that Federal Reserve officials aren’t committing to their forecast of the appropriate policy path.

“It is a snapshot of a point-in-time forecast by 19 different people with 19 different forecasts,” Jefferson said. “That forecast is done at a specific point in time, four times a year. But a lot happens after that forecast is made.”

Dot Plot, Market Forecasts Often Wrong

Events that happen in the wake of the forecasts can often make them irrelevant quickly. For example, last time Fed officials predicted they would cut interest rates three times before the end of the year and that was quickly followed by data showing stickier-than-expected inflation.

Economists at Wells Fargo said recently that this time around, the median prediction is likely to be one or two cuts, depending on data released in the interim.

Recent research from Apollo Chief Economist Torsten Sløk shows that the ever-changing data often make these predictions incorrect.

“The Fed’s and the market’s forecasts about the future path of the Fed funds rate are almost always wrong,” he wrote. 

However, the dot plot may be doing exactly what it was designed to do. When the dot plot was first included in the economic projections in 2012, officials hoped the predictions would help give transparency into the FOMC’s decision-making process. Like most of the committee’s communications, it was part of a larger effort to avoid shocking the markets.

In mapping out the change in the federal funds rate along with forecasts for future rate changes, Sløk found the Fed was able to lead the markets through its projections. 

“The direction of the forecasting mistake is always identical, suggesting that the market is taking its cue about the future path of interest rates from the Fed’s dot plot,” he wrote.