The Fed hikes, and its chair skips the dot plot

The Federal Open Market Committee raised the federal funds rate by 25 basis points to 3.75–4.00 per cent on 18 September. Wall Street was more startled by what was left out. Chairman Kevin Warsh chose not to submit his own rate projection to the quarterly Summary of Economic Projections, the dot plot, something no Fed chair has done before.

A dot that says a lot

Since the Summary of Economic Projections began, no chair has held back a personal projection. Warsh's decision sends a clear and hawkish message. He regards the dot plot as a misleading exercise with a veneer of science that ties the central bank's hands. By keeping his dot to himself he has avoided committing to any path for rates, which leaves him free to tighten further whenever he chooses.

How the dots came to matter

The Fed began publishing its policymakers' projections for the funds rate in January 2012, adding them to economic forecasts it had released quarterly since 2007. Every participant submits a dot, voters and non-voters alike: the governors in Washington and all twelve regional bank presidents. The dots are anonymous, and the chart shows each participant's view of the appropriate rate at the end of each year, conditional on that person's own forecast for the economy.

Markets soon began treating the median dot as a promise. That was never the intention, since each dot reflects one official's guess and the median can shift with a single change of mind, but the chart became a focal point for traders trying to price the path of policy. Critics have long argued that it encourages the Fed to anchor on a path it has drawn itself, and that walking away from a published path looks like a policy error even when the data justify it.

16 of 18 expect more

Even without the chair's dot, the chart was hawkish. Sixteen of the eighteen committee members who submitted projections pencilled in further rate increases before the end of the year.

That count matters more than the missing dot. A chair can steer the committee through the statement, the press conference and private persuasion, but a chart in which almost every participant expects further rises shows where the centre of gravity already lies. With only two of the eighteen seeing no further move this year, a pause at the next meeting would require a sharp change in the data.

The missing dot also changes the arithmetic. With eighteen projections rather than nineteen, the median becomes the average of the ninth and tenth dots rather than the tenth alone, which can move where it lands. Analysts used to assume the chair's dot sat near the median, since chairs rarely stray far from the consensus they build, and they have now lost their best clue to his thinking.

The rise itself passes through quickly. Banks' prime rates usually move the same day as the funds rate, lifting the cost of credit-card balances, home-equity lines and many small-business loans, while yields on money market funds and Treasury bills adjust within days. Savers gain at once, and borrowers on floating rates start paying more with their next statement.

From guidance to surprise

The Fed has tried the opposite approach before. Between June 2004 and June 2006 it raised rates at seventeen consecutive meetings in steps of 25 basis points, having told markets the pace would be measured. The predictability kept markets calm, but critics later argued it also encouraged the risk-taking that fed the housing bubble, since investors could borrow short and lend long knowing exactly what was coming. Warsh's approach bets that less certainty about the path of rates will make markets more cautious.

The cost of that bet falls on anyone who needs to plan. Without a clear path from the chair, every data release and every speech carries more weight, which raises volatility in short-term rates and tends to widen the term premium on longer bonds. Companies setting budgets and banks pricing loans will have to allow for a wider range of outcomes. Savers gain from rates that stay higher for longer, while floating-rate borrowers lose the ability to plan around a published path.

Other central banks already work with less guidance. The Bank of England publishes no individual rate projections from its policymakers, and the European Central Bank has decided meeting by meeting on the incoming data since 2022, declining to commit to a path. A Fed that withholds guidance would be moving closer to its peers, although none of them had published a chair's projection and then stopped.

The case for more guidance

The strongest objection is that guidance works. When a central bank tells markets what it intends, long-term rates move ahead of policy, and the bank can achieve a given tightening with fewer actual rate rises. A chair who withholds his view may simply shift attention to the minutes, speeches and leaks, making communication noisier without making policy more flexible. The committee's other members also still publish their dots, so the market has a map, if not the chair's own route on it.

The minutes of this meeting, due three weeks after the decision, will show how the committee debated the chair's choice, and Warsh's speeches before the next meeting will fill some of the gap. Warsh has given up on steering markets with forward guidance. Investors will get less warning of each move, and with sixteen of eighteen officials expecting more hikes this year, they should brace for at least one more before December.