Fed wants markets to stop taking dot plot so seriously

Since the day they were unveiled in January 2012, the Federal Reserve’s interest rate forecasts have been criticised for taking on too much importance and become fodder for mockery in financial markets.Now, officials are trying to adjust that signal while preserving transparency. One problem: The quarterly forecasts - arranged in a so-called dot plot where the little circles represent each Fed officials’ projection for the appropriate level of the benchmark federal funds rate - become stale as new data arrive. Yet they remain out there as the Fed’s best guess about future policy.What’s more, financial markets often disagree with the dot plot, exposing a gap in communication that can be costly. Market perceptions of the central bank’s intentions help set rates on everything from government bonds to mortgages and car loans, and the Fed wants investors to understand how their views change with new information. The dots can’t do that.The rate forecasts “seldom add anything useful beyond the communication already presented by the Fed - press conferences, the statement, speeches, and testimony,” said Jon Faust, director of the Center for Financial Economics at Johns Hopkins University in Baltimore and a former adviser on communications to Chair Janet Yellen. “We should have all learned that they don’t say where policy is going.”When Fed officials released a fresh forecast on December 16, the median of their estimates signaled four rate hikes for 2016, whereas investors were much more cautious. Pricing in interest rate futures markets suggested a 9% probability that policy makers’ rate-hike outlook was correct, according to data compiled by Bloomberg.Dissatisfaction with the dots seems to be growing. St Louis Fed President James Bullard, a voting member of the policy-setting Federal Open Market Committee this year, said in a Bloomberg News interview that the rate projections contribute to uncertainty.“I’ve even thought about dropping out unilaterally from the whole exercise,” he said. The dot plot is part of a longstanding Fed effort to communicate better about its thinking, driven by the belief that policy is more effective when markets understand where the central bank is heading. It’s a work in progress. Fed Vice Chairman Stanley Fischer is leading an internal subcommittee which is trying to figure out ways to tell the public that the dots are at best a guess in a moment in time about what rate would best achieve their economic forecasts.One proposal, revealed in minutes of the Fed’s January 26-27 meeting, is to use a fan chart to illustrate how much uncertainty there is around the forecast. This could help the public understand that rates could be higher or lower than the dot plot’s median estimate.Such a move would help diminish the dot plot’s signal, but it also raises the question of whether the Fed should focus on other forms of telling investors how it might react to new information.Another possibility discussed by academics and former Fed officials is to leave the dots as they are and focus on describing scenarios instead. These would be charts of how policy makers would respond to shocks and surprises that diverge from their baseline outlook, or their best guess about how the economy and policy will develop.This is, in fact, what they are trying to communicate all the time. The Fed staff, transcripts of FOMC meetings show, already does this with a computer-generated scenario with a fed funds rate path. At the moment these documents are released to the public with a five-year lag.“I like that idea better than a fan chart” around the median dot estimate, said Laura Rosner, US economist at BNP Paribas in New York. Yellen “could walk us through the scenarios in her press conference and discuss how policy might respond.”Faust, who is in favour of retiring the dots, said they do achieve two of the big goals of former Fed Chairman Ben S Bernanke.As a successor to Alan Greenspan, whose views had a big weight in policy decisions, Bernanke set out to invest more authority in the FOMC and boost its accountability. The dots show just how diverse views can be.In March, for example, the range on federal funds rate estimate was 0.6% to 1.4% for the end of the year.A woman walks past the Federal Reserve building in Washington. Market perceptions of the Fed’s intentions help set rates on everything from government bonds to mortgages and car loans, and the central bank wants investors to understand how their views change with new information.