To The Moon

At the June FOMC meeting, Fed unsurprisingly paused the rate hikes. However, Fed Chairman Powell stated during the subsequent press conference, “This pause does not imply that the benchmark interest rate has reached its peak.” The dot plot released at the same time indicated that FOMC members anticipate two additional rate hikes totaling 50 bps by the end of this year.

Strangely, the market seemed unfazed by such hawkish remarks, and US stocks only experienced a slight decline on that day. Looking at the Fed Fund Futures traded in the market, the expected benchmark interest rate for December not only failed to surpass previous highs but also remained significantly lower than the median of 5.625% indicated in the Fed's dot plot.

Source: Bloomberg

So, is the benchmark interest rate indicated by the Fed's dot plot as accurate as it claims to be, considering that the Federal Reserve serves as both a "player" and a "referee"? Let's explore the truth using data.

1. What is the FOMC dot plot?

The FOMC, short for the Federal Open Market Committee, is responsible for conducting open market operations, i.e. deciding the benchmark interest rate.

The dot plot reflects the projections of FOMC members regarding the expected year-end benchmark interest rate of the next 1-3 years. The median value from these projections is typically taken as the forecasted value in the Federal Reserve's dot plot. Generally, the dot plot is released following the FOMC meetings in March, June, September, and December each year.

Source: Bloomberg

Source: Bloomberg

2. Have the June dot plot projections been accurate in history?

We have analyzed the June FOMC dot plots from 2012 to 2022, spanning the past decade, to assess the accuracy of predictions for the current year (T+0), the next year (T+1), and the year after (T+2).

Considering the benchmark interest rate range of 0.25%, any median value within or below 0.25% can be considered as a correct prediction. Statistically, the June dot plot is 60% accurate in predicting rates at the end of the current year, but less accurate for the year-end rates of T+1 and T+2.

Source: Bloomberg and Tiger Trade

3. How accurate are the historical dot plot forecasts for different quarters?

To further quantitatively examine the accuracy of Fed's dot plot, we define the "dot plot prediction deviation" as the difference between the median value in the dot plot and the actual median market rate in the future. It is calculated as follows:

Dot Plot Prediction Deviation_yyyymm = ABS (Dot Plot Prediction Value_yyyymm - Actual Future Value_yyyy)

For example, in June 2022, the dot plot indicated a median rate of 3.375% for the year-end of 2022, while the actual year-end benchmark interest rate was 4.375%. Therefore, the Dot Plot Prediction Deviation_202206 = |4.375% - 3.375%| = 1%.

For all the dot plot data from the past decade of FOMC meetings, we calculated the dot plot prediction deviation for the current year (T+0), the next year (T+1), and the year after (T+2). The average values based on the month of dot plot publication are as follows:

Source: Bloomberg and Tiger Trade

The following patterns can be observed:

• As the year-end approaches, Fed' dot plot predictions tend to be more accurate as it gathers more information. Among them, the dot plots in June, September, and December are quite close to the year-end predictions for T+0.

• However, Fed is not an infallible "prophet," and dot plot predictions with a span of more than six months often deviate significantly from the actual future market rates.

4. Conclusion

In summary, Fed's dot plot is not an official "advance declaration" but rather reflects the attitudes of committee members based on the current state. It provides guidance for interest rate trends in the next six months but is less accurate for predictions beyond that timeframe.

Therefore, based on the latest June dot plot, the interest rate is projected to reach 5.625% by the end of 2023. Although the market may not fully agree with this projection at the moment, historical experience suggests that the dot plot has a decent success rate in predicting the benchmark rate in six months.