Dot Plots are charts used by the US Federal Reserve (Fed) to indicate the forecasts of Federal Open Market Committee (FOMC) members regarding future key interest rate levels, in particular the Fed Funds rate. This chart, published after certain FOMC meetings, is a key communication tool for anticipating the evolution of US monetary policy.
How Dot Plot works
The Dot Plot takes the form of a graph in which each dot represents an FOMC member’s projection of the level of interest rates at the end of the current year, as well as for the coming years. These projections also cover longer-term forecasts. Each committee member indicates his or her estimate of the ideal policy rate for each future period. However, the points are not named, so it is impossible to know which member made which projection.
The Dot Plot is generally divided into three sections:
- Projections for the current year: This section shows where FOMC members expect the Fed Funds rate to be by the end of the year.
- Projections for the coming years: The chart also shows forecasts for the next few years, offering a perspective on the Fed’s medium-term interest rate intentions.
- Long-term projections: This part of the Dot Plot reflects expectations of the long-term neutral rate, i.e. the interest rate deemed appropriate once the effects of economic crises and cyclical fluctuations have dissipated.
Why is the Dot Plot important?
The Dot Plot is crucial for investors, economic analysts and the financial markets, as it offers a glimpse of the Fed’s expectations regarding future interest rate trends. Here are a few reasons why it is so influential:
- Indication of future monetary policy: Although the Fed Funds rate is determined at regular FOMC meetings, the Dot Plot offers clues as to the direction monetary policy may take in the months and years ahead. This helps investors adjust their strategies in line with expectations of higher or lower rates.
- Financial market reactions: forecasts of rate hikes or cuts influence stock, bond and currency markets. If the Dot Plot shows that FOMC members are forecasting a faster-than-expected rise in interest rates, this can lead to a fall in equities and a rise in bond yields. Conversely, forecasts of steady or falling rates may push equities higher.
- Fed transparency: The Dot Plot is a tool used by the Fed to increase the transparency of its monetary policy decisions. By publishing the forecasts of FOMC members, the Fed helps market players to better understand internal debates on interest rates and future economic risks.
Dot Plot limits
Although the Dot Plot is useful for understanding the Fed’s intentions, it has certain limitations:
- Uncertain projections: Dot Plot points represent forecasts that may change according to economic conditions. For example, if future economic data differ from expectations, rate forecasts may change at subsequent meetings.
- Diversity of opinion: Each point reflects the view of a single FOMC member, and there can be significant discrepancies between individual projections. This can make it difficult to interpret a clear trend, especially when there is significant dispersion of points.
- Not a guarantee: The Dot Plot does not represent a firm commitment by the Fed to act on the projections. It is an indicator of sentiment at a given point in time, but final decisions depend on actual economic conditions.
Dot Plot example
Let’s take a concrete example. If a Dot Plot shows that the majority of FOMC members are planning a rate hike for next year, this could signal that the Fed is concerned about a possible overheating economy or accelerating inflation. On the other hand, if the dots on the chart indicate little change in short-term rates, it could mean that the Fed is expecting moderate growth or is concerned about risks of economic slowdown.
