What The New Fed Dot Plot Is Telling Us

As expected, the Federal Reserve raised interest rates on Wednesday by 25 basis points to a target range of 50-75 basis points.

During the press conference, Janet Yellen noted that "near term risks to the economic outlook appear roughly balanced." She noted improvement in GDP, unemployment, manufacturing and even wage growth. The markets had a small spike briefly following the announcement before settling down around 0.5% on the day.

One of the more intriguing pieces that gets released during Fed press conferences is the Fed Dot Plot. This is the report that indicates where the members feel interest rates are heading over the next few years. The Dot Plot isn't official but it does give us something to talk about. I haven't put much weight into the Dot Plot mostly because of how wrong it's been in the past. The reports from over the past couple of years have regularly called for multiple rate hikes only to have none of them come to fruition.

I wrote a piece for Seeking Alpha last year talking about the Dot Plot from the Fed meeting one year ago. In it, every single member surveyed forecasted at least two rate hikes in 2016. The average forecast called for rates to rise 100 basis points during the year with one member even calling for rates to rise by 175 basis points.

Needless to say, none of it came true as we saw our only rate hike for the year come today. It's impossible to see a week into the future, let alone a few years so this report needs to be taken with several grains of salt.

So let's take a look at this quarter's plot.

This chart comes from the FOMC and shows how opinion on interest rate direction has changed over just the past three months. Red is the September Dot Plot and blue is December.

If we're looking at the survey results as a whole, the Fed is essentially telling us that it's forecasting three rate hikes in 2017. Given the past hesitation of the Fed to move rates north along with the inconsistency of the data presented, I feel like three hikes may be a little optimistic. Janet Yellen said all the right things and most of the data suggests that an economic recovery is in place but I'm expecting that the Fed won't be eager to move too far too fast. I'm anticipating two rate hikes in 2017, one in the first half of the year and one in the second.

A few other observations...

  • It's interesting to see a bit of division back in September over what should happen in the 4th quarter of 2016. 14 of the 17 members saw a rate hike yesterday. Three thought there should a 50 basis point hike while one thought there should be a 75 basis point hike. Although there was some chatter yesterday that a 50 basis point hike wouldn't be entirely unwelcome, the odds of that happening seemed virtually nil.
  • As mentioned earlier, last year's December Dot Plot forecasted four rate hikes. This was in fairly sharp contrast with what many financial experts were expecting at the time. A number thought we were headed towards a "one and done" scenario while some couldn't see the Fed raising more than two times. This quarter's Dot Plot seems more in line with consensus expectations. The market is as well positioned as it has been in years to handle higher rates and I expect we'll see multiple hikes in 2017.
  • Of the 17 members surveyed, not one sees less than one more hike coming in 2017. That seems reasonable.
  • The Fed seems ready to hit the gas on rate hikes over the next few years. Sentiment seems to have improved enough over the past three months that Fed members are now anticipating an additional rate hike. The averages from the Dot Plot indicate that right now the Fed is expecting three rate hikes in 2017, three more in 2018 and three more in 2019. Consensus obviously begins to fall apart the further you go out but it looks like the low rate policy of the last several years will end very soon.

The Fed futures market seems to be pricing in a similar trajectory. It's anticipating the greatest likelihood at around 2-3 rate hikes in 2017 with roughly a 1-in-5 chance that rates will be at least 100 basis points higher 12 months from now.

While the Fed seems prepared to raise rates at a steady clip for the foreseeable future, let's not forget that a lot could change over the next 12 months. We have a new president who's installing an entirely new cabinet with an agenda that's as of yet still unknown. How the uncertainty in foreign relations, deregulation and business investment will ultimately play out after the January inauguration remains to be seen.

The Fed Dot Plot is a fun read but it's ultimately a guess based on incomplete information. Don't put too much weight into it and you likely won't end up disappointed!

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