What Is The Fed Dot Plot And Why Is It So Important?
The Federal Reserve issued its monthly statement on Wednesday, and one of the primary areas of interest for investors is the Fed “dot plot” chart for 2020.
What Is The Fed Dot Plot?
Investors get monthly interest rate updates from the Fed throughout the year, but four times per year the Fed also issues its Summary of Economic Projections (SEP). The SEP includes a chart of projected future interest rates known as the dot plot.
The dot plot represents projections by each Fed official of future fed funds rates. Each dot on the chart represents one Fed official. However, the dot plot is anonymous, so investors can’t tie individual projections to individual Fed officials.
The dots represent the appropriate target Fed funds rate at the end of the next three calendar years as well as one dot for the longer-term. The Y-axis of the dot plot represents the target fed funds rate, and the X-axis is the forecast year.
Interpreting The Fed Dot Plot
Investors often identify several key pieces of information from the dot plot.
First, they look at the median target rate for the given period by taking an average of all the dots. Second, they look for how much variance there is in each time period to get a sense of the clarity of the economic outlook. If all the dots are clustered together, it’s a sign that all Fed members are on the same page. If there is a lot of variance in the dots, investors may see that as a sign the forecast is unreliable.
Finally, investors look to see how the dot plot has changed since the previous SEP. If the forecast rates for the coming year have risen, it’s a hawkish sign and could be bad news for stocks and other investments. If the median rates have fallen, it’s a dovish indication that the Fed intends to be more supportive with its monetary policy.
The Latest Dot Plot
The dot plot below is taken from the Fed’s latest SEP released on Wednesday. The median 2020 interest rate is 1.625%, down from 1.875% in September. The 2020 dots are also more consolidated compared to Septembers plot, which showed dots ranging from 1.675% all the way up to 2.375%. December's plot shows 13 officials anticipate interest rates will not change in 2020, while four are predicting one 0.25% rate hike next year.
Nicholas Colas, co-founder of DataTrek Research, said the updated 2020 dot plot was the most eye-catching part of Wednesday's Fed report.
“The standard deviation of their guesses is just 0.11, less than half the year-ago levels of certainty about rates in 2019 (0.26). In fact, the Fed has never been more certain about December’s forward-year rate policy since they started releasing the 'Dots,'" Colas said.
While the Fed didn't signal any changes to monetary policy, the fact that officials all seem to be mostly on the same page looking ahead to 2020 reduces uncertainty in the market and should be considered bullish for investors. In fact, the SPDR S&P 500 ETF Trust (NYSE:SPY) traded higher by 0.2% on Wednesday.
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