You will be able to read the Fed's dot plot and explain why markets and the Fed's own projections often differ.
Four times a year the Fed publishes a chart of dots, and within minutes the headlines announce how many rate cuts or hikes are "coming". Marcus used to treat those headlines as a schedule. Then he looked up an old dot plot and compared it with what actually happened. The gap cured him of the habit, and this lesson shows you why.
The dot plot is part of the Fed's Summary of Economic Projections, published after four of its eight scheduled policy meetings each year, in March, June, September and December. Each participant in the Federal Open Market Committee, the governors and the regional Fed presidents, marks where they think the federal funds rate should be at the end of each of the next few years, and in the longer run.
Each dot is one person's view of appropriate policy, given their own forecast for the economy. The dots aren't votes, and they aren't a committee decision. The figure that headlines quote is the median dot for each year, the one in the middle.
The longer-run dots are worth a look too. They show where participants think the rate settles once the economy is in balance, which is their estimate of the neutral rate. When that estimate moves, it changes what "high" and "low" rates mean.
The same release includes projections for growth, unemployment and inflation. Read them together with the dots. A median dot showing cuts alongside a forecast of falling inflation tells a consistent story. Dots showing cuts while inflation forecasts rise would be a puzzle worth noting.
Futures markets price their own expected path for the federal funds rate. Traders buy and sell contracts whose value depends on where the rate will be at future dates, so the prices imply a path. CME Group's FedWatch tool turns those prices into probabilities for each meeting, and many financial news sites show the implied path.
The two paths often differ. The dots show what officials think they will do if their forecasts come true. The futures path shows what traders expect the Fed will actually do, weighted by the chance that the economy turns out differently, plus a small premium for risk. When markets price more cuts than the dots show, traders are betting the economy will weaken more than the Fed expects, or that the Fed will blink. When they price fewer, they doubt the Fed will deliver.
Neither is reliably right. The useful information is the gap: it tells you where the market and the Fed disagree, and that's where the next surprise is most likely to come from.
In December 2021, the median dot for the end of 2022 was below 1%. Inflation kept rising, and by the end of 2022 the Fed had raised its target range to 4.25% to 4.5%. The median official missed the year-end rate by more than three percentage points, with the projection made only twelve months earlier.
That episode is extreme, but misses are normal. The dots depend on forecasts for growth and inflation, and those forecasts carry large errors a year or two out. In the years after the 2008 crisis, the dots repeatedly showed faster rate rises than the Fed delivered. Fed chairs have said in press conferences that the dots are not a committee plan, and the record above shows why they say it.
If you'd bought long-dated bonds in early 2022 because the dots showed a gentle path, the 2022 bond losses from lesson 2.7, Risk premia: what you are paid to hold equity, term, credit and illiquidity, would have hit you in full.
Use the dots to understand how officials are thinking: whether they see inflation as the main risk or growth, whether their view of the neutral rate is moving, and how widely they disagree with one another. A wide spread of dots means the committee itself is uncertain, which makes surprises more likely.
Don't use them to forecast rates or to time a bond purchase. And don't build a holding around a particular number of cuts. That is the same discipline as lesson 3.4, Central bank reaction functions: the Fed and MAS, applied to the Fed's own words. You want to know which way the reaction function points and what would change it, not a date.
For Marcus, the dots go on his macro dashboard as context. His bond fund's duration, from lesson 2.5, tells him what a rate move would cost. The dots and the futures path tell him which direction officials and traders currently lean, and how far apart they are.
For the activity, find the latest dot plot on the Federal Reserve's website and the futures-implied path from a source such as CME FedWatch, then note the year-end rate each shows and where the gap between them is largest.
Compare the latest dot plot's median path with the rate path priced in futures and note where they differ.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).