What the Fed's forecasts really say

The Federal Reserve held its benchmark rate in June but raised the median projection for where rates will peak to 5.6 per cent. The Summary of Economic Projections was a blow to anyone betting on cuts. The median path now includes two more quarter-point increases. The committee sees the economy's resilience as a direct threat to further progress on inflation.

From 5.1 to 5.6

The decision on 14 June left the target range at 5-5.25 per cent after ten consecutive increases, and the vote was unanimous. The projections moved much further than the rate. In March the median official expected rates to end the year at 5.1 per cent, consistent with one last increase and a long hold. Three months, a banking scare and a run of firm data later, the median has risen by half a point. Officials also raised their growth forecast for this year to 1.0 per cent and cut their year-end unemployment forecast to 4.1 per cent, conceding that the slowdown they had pencilled in has not arrived.

The path beyond this year moved too. The median official now sees rates ending next year at 4.6 per cent, higher than in March, which implies cuts only after the peak has been held for some months. Officials are telling markets both that the top is higher and that the descent will start later.

The hawks hold the pen

A closer look at the spread of the dots shows that the committee's hawks are now setting the tone. Officials raised their forecasts for core PCE inflation, which suggests they no longer expect falling goods prices to pull services inflation down to target without pain. The peak rate is going up, and the Fed expects to keep it there longer.

The distribution says more than the median. Of the eighteen officials who submitted projections, only two saw no further increase this year, while twelve pencilled in at least two more and three of those wanted more still. With eighteen dots, the median sits between the ninth and tenth, so several officials would have to change their minds to pull it down. Core PCE inflation is now expected to end the year at 3.9 per cent, up from 3.6 per cent in March, while the committee's estimate of the long-run neutral rate stays at 2.5 per cent. On those numbers officials already regard policy as tight, and a majority want it tighter.

Why the dots exist

The dot plot was first published in January 2012, when rates were stuck near zero and the Fed wanted to show how long it expected to keep them there. It was designed to reinforce a promise of easy money, and in that role it worked reasonably well. Using it to signal tightening is harder. Each dot is one official's view of appropriate policy, assuming the economy evolves as that official expects, and nobody is bound by it. The chair has repeatedly warned against reading the projections as a committee plan, which is precisely how markets read them.

Markets are not convinced

Traders took the message only in part. Futures markets priced a good chance of another increase in July but stopped short of the second that the median implies. That scepticism has a basis. The dots are forecasts rather than promises, and their record is poor: in December 2021 the median official expected rates to end 2022 below 1 per cent, and the Fed then raised them by more than four percentage points during that year. The dots proved far too dovish then, and markets are betting they prove too hawkish now. Jerome Powell described July as a live meeting, the Fed's shorthand for keeping an increase on the table.

There is precedent for the other kind of error too. In December 2018 the median official projected two more increases for 2019, and the Fed instead cut rates three times that year as growth slowed and trade tensions rose. Markets that bet against the dots then were proved right within months. The pattern is that the projections tend to extrapolate the recent past, so they lag turning points in both directions.

Other central banks are not waiting. The European Central Bank raised its deposit rate to 3.5 per cent the day after the Fed's decision and signalled that it was likely to move again in July. That keeps pressure on the dollar, since a Fed that holds while Europe tightens narrows the rate gap that has supported the currency, and it weakens any claim that the global tightening cycle is over.

What would bend the dots

The case against the hawks rests on lags. Much of last year's tightening has yet to reach borrowers, bank credit has tightened since the spring failures, and rent growth on new leases has slowed sharply, which should drag shelter inflation lower over the coming year. If those forces bite, the second increase in the median may never come. The evidence will arrive in the core PCE figures at the end of this month, the June consumer price report in mid-July and the monthly payroll numbers. Anyone betting on cuts this year needs all of them to weaken at once, and needs the committee to abandon a forecast it published only this week.

The new dot plot tells investors that the Fed regards a strong economy as an inflation problem to be squeezed out. Anyone expecting rate cuts before the end of the year is likely to be disappointed, and the July meeting will probably bring at least one of the two increases the median promises.