How to read the Fed’s projections like a pro

Federal Reserve officials will announce both an interest rate decision and a new set of economic forecasts on Wednesday. According to estimates, Wall Street has been eagerly awaiting what next year could bring.

Officials are expected to leave interest rates unchanged within a range of 5.25 to 5.5 percent, the highest level in 22 years. Policymakers had predicted a final rate hike in 2023 in their last quarterly economic forecasts. in September. But recent progress in the Fed’s battle against inflation has investors expecting the central bank’s next move to be a rate cut.

The question now is when the interest rate cuts will start – and how quickly borrowing costs will fall. For hints on that, investors will look to the Fed’s new forecasts. Here’s how to read the numbers.

The dot plot, decoded

When the central bank releases its figures Summary of economic projections Every quarter, Fed watchers focus obsessively on one part in particular: the so-called dot plot.

The scatter plot will show Fed policymakers’ estimates for interest rates at the end of the next few years and over the longer term. The forecasts are represented by points arranged on a vertical scale: one point for each member of the Federal Open Market Committee.

Economists are closely watching how the range of 19 estimates shifts as it could provide a hint as to where policy is headed. They fixate most intently on the middle dot, currently the 10th. That middle official is regularly cited as the clearest assessment of where the central bank sees policy heading.

The Fed is trying to reduce inflation, and to do that, officials have raised interest rates to slow spending, limit business investment and expansion and cool the labor market. The central bank quickly raised interest rates between March 2022 and July 2023.

But policymakers have kept rates steady since the July hike. And while officials had expected a step further from September, to a range of 5.5 to 5.75 percent, they are now widely expected to leave rates unchanged at this meeting.

The question is to what extent they expect interest rates to fall in 2024. If policymakers see borrowing costs at 5.1 percent at the end of 2024, as they did from September, that would only imply a quarter-point interest rate cut. If they lower that forecast to 4.8 percent, it could indicate they expect to cut rates twice.

An important trick for reading the dot plot? Note where the numbers fall relative to the longer-term median projection. That number is sometimes called the “natural” or “neutral” rate, and was recently 2.5 percent. It represents the theoretical dividing line between simple and restrictive monetary policy.

What the Fed is saying when rates are above that neutral rate is that they are in an economically restrictive zone.

Unemployment forecasts can be interesting

One of the biggest questions in this cycle of rate hikes is whether the Fed can accomplish its job of lowering inflation without causing a big jump in unemployment — what economists often call a “soft landing.”

On page two of the economic projections are some hints about how Fed officials think about this question.

Fed officials previously predicted that the unemployment rate would rise to 3.8 percent by the end of this year, then fall to 4.1 percent in 2024 and 2025. In November, the unemployment rate was 3.7 percent.

What will be interesting to watch on Wednesday will be whether policymakers still think they need noticeably softer labor market conditions in a world where inflation has already cooled significantly.

View the growth prospects

The road to higher unemployment is paved with slower growth. To slow the labor market, officials typically think they need to cool the economy as a whole below its potential — forcing it to keep running while allowing it to keep running.

Growth has surprised the Fed all year and was especially strong in the third quarter. It’s worth checking whether policymakers still expect the economy to remain modest in 2024: it did expected earlier only a rate of 1.5 percent by the end of next year, well below the long-term sustainable rate of 1.8 percent.

Approach inflation estimates with caution

Fed officials are likely predicting that inflation will slow in the coming years, in part because they always do. By definition, the Summary of Economic Projections contains predictions about what the economy will look like if policy is set properly – and appropriate policy means an interest rate level that over time pushes inflation back toward the Fed’s target of 2 percent.

Still, it will be remarkable how quickly Fed officials think they can bring inflation fully back to target. In their latest forecast, officials did not expect to get back to target until 2026. But given recent progress, they may now be more optimistic.