In the hours leading up to the Federal Open Market Committee’s (FOMC) latest meeting, the CME FedWatch Tool showed that market participants had priced in expectations of a 59% chance of a 50bp (50 basis points; 0.50%) rate cut and a 41% chance of a 25bp cut.
There were no expectations of a rate hike or that the Fed would maintain rates at the same level.
But the most important decision coming out of this meeting wasn’t the decision to cut rates by 0.5%, it was the Fed’s “dot plot,” which reflects their expectations for the “glide path” that rates will take in the year ahead.
The Summary of Economic Projections (SEP), which includes the dot plot, serves to telegraph the Fed’s forward-looking expectations on a number of key metrics, including GDP, the unemployment rate, PCE inflation and the more pressing Core PCE inflation.
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The SEP is updated quarterly, and the prior update (with the June meeting) showed that the Fed, as a body, expected minimal downward pressure on rates for the balance of the calendar year.
The dot plot above shows that 11 voting members of the Fed expected it would be appropriate to hold rates at 5.25 – 5.50% (four members) or to lower them slightly (to 5.0 – 5.25%; seven members) by the end of 2024.
The other eight votes called for two rate cuts by year’s end (to 4.75 – 5.0%).
In the plot, you can also see that the bulk of the Fed expected the fed funds rate to remain above 4% (4.0 – 4.25%) by the end of 2025 and then fall roughly another point by the end of 2026, with a “Longer run” rate target in the neighborhood of 2.75%.
The dot plot from the September meeting, however, painted a much different picture.
As you can see, the Fed is now largely in favor of an additional 50bp of cuts this year, which would bring rates down by a full 1.0% from previous highs, with rates dipping to the mid-3s by the end of 2025 (the 3.25 – 3.50% range has a slight edge over the 3.0 – 3.25% range due to a few members in favor of slightly higher rates).
How Does the Dot Plot Affect Us as Investors?
The dot plot offers us, as investors and savers, two important takeaways: 1) if the economy is moving “according to plan,” we can use the information tactically, and 2) we can use it as a check against other economic data points.
If It’s All Going According to Plan
Cash rates are incredibly attractive right now, all things considered, with yields on things like CDs, high-yield savings accounts (HYSAs) and short-term Treasuries at the highest levels they’ve been this century.
That’s a huge windfall for short- or intermediate-term savers. A 5% rate on cash in a low (or lower) inflation environment can ease the pain of watching a market near all-time highs while you’re sitting on cash that you’ve got earmarked for something in the next year or two.
If, for instance, you’re saving up for a down payment on a house, have cash set aside for a new vehicle, wedding, college expenses, etc., you can generate meaningful returns in cash.
The value of the dot plot is that it can help you game out the viability of your strategy.
Understanding that the Fed expects rates near 3.25% at the end of next year can take a lot of uncertainty out of the equation. And, assuming that inflation stays at or near the current levels, you can price that into your assumptions (to some degree).
Cash rates above inflation mean that your purchasing power should outpace expected cost increases.
However, if you’ve been banking on elevated cash yields for better longer-term returns, you may need to begin looking elsewhere.
Using the Dot Plot as a Check Against the Headlines
New economic data comes out every week. There’s always some price index, unemployment figure, jobless claims number, or something else.
Now, the SEP isn’t a particularly timely item (comes out quarterly), but it is useful as a check against what are typically negatively biased headlines.
Is a monthly unemployment figure that’s worse than expected actually bad news?
It depends on the week. There are plenty of times when the headlines will tell you that the market dropped in response to some report or another.
But are the headlines actually getting at the root cause of market turbulence?
Probably not.
If the Fed has actually engineered a soft landing, we should expect to see little change to the dot plots that come out each quarter, because some economic weakness is part of the plan.
But if we see the Fed moving interest rate targets lower following a slate of bad headlines, it can signal that the Fed is worried about the overall economy and, in the aggregate, the headline “smoke” may be pointing towards an economic “fire.”
For the time being, the market is looking for signals that it remains appropriate to be in “risk-on” mode, and a Fed that’s flipped from foe to friend is a green light.
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