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How to read the US Federal Reserve dot matrix?

March 21,2022 00:48:41

On Thursday morning, the Fed’s March resolution was officially released. As expected by the market, the interest rate increased by 25 basis points. In addition to raising the interest rate, the monetary policy statement emphasized “widespread price pressures”, and predicted a sharp upward revision on the PCE inflation forecast at the end of this year. The dot matrix shows that the number of interest rate hikes in 2022 has increased significantly to 7 times, and there are 7 members who believe that interest rates should be raised more than 7 times, which is far beyond the market expectations. So, what exactly is a dot matrix?

The so-called dot matrix is a graph that predicts future interest rate increases or interest rate cuts, and it is a kind of forward-looking information. The main purpose of the Fed’s announcement of the dot matrix is to strengthen its communication with the market so that the market can have a better understanding on the information that the Fed give out. Generally, the Fed releases a dot matrix in every three months.

So how is the dot matrix made? The horizontal axis of the dot matrix is the timeline, and the vertical axis indicates the possible range of future interest rates. The committee members give their predictions on the future interest rates, which are reflected in the dot matrix. Each dot represents a member who made the prediction. Generally, the Fed each time raises interest rate by an average of 0.25%, namely 25 basis points. Assuming that the current interest rate is 0~0.25%, one member predicts that the interest rate will reach 0.5% ~0.75%, which suggest that there will be two times of interest rate rise.

When the Fed releases the dot matrix, it will also announce the intermediate interest rate, which represents the Fed’s expected future interest rate. The median value is not the average value but is calculated in a certain way based on the numbers predicted by the members. First, arrange all the numbers from low to high. If the number of members who make a prediction is odd, then the middle number is the median. If the number of members who make a prediction is even, then take the average of the middle two numbers as the median. Based on this median rvalue, an inference can then be drawn on how many times Fed members believe that the interest rate will increase this year. For example, the median interest rate is 1.9%. As mentioned earlier, the Fed generally raises interest rates by 0.25% on average each time, and 1.9% is still 6 times interest rate increase away from the current interest rate after the rise this time.

So, is the prediction on the pace of future interest rate increases based on the dot matrix’s expectation reliable? From past experience, the Fed predicted in the dot matrix in December 2015 that it would raise interest rates 4 times in 2016, but in reality, it only raised interest rates 2 times. Therefore, the dot matrix reflects more on the attitude of members towards interest rate increase, rather than the actual time of interest rate increases during the year. The International Monetary Fund has also made multiple recommendations to the Fed, suggesting that the Fed should change its way of communication and stop providing dot-matrix maps generated from Fed officials’ interest rate forecasts. This time, the dot matrix predicts that the Fed will raise interest rates six times during the year. What we can take away from this release is that the Fed may raise interest rates more frequently in this year than in past years.

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