The Federal Reserve Could Raise Interest Rates Faster Than We Thought

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In addition to raising interest rates at its latest meeting, the Federal Reserve also released its latest "dot plot," which shows us where the FOMC members see interest rates going in the future. In this clip, host Michael Douglass and banking specialist Matt Frankel discuss the dot plot and how it's changed over the past few months.

A full transcript follows the video.

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This video was recorded on March 26, 2018.

Michael Douglass: The fact that the Fed raised rates this latest meeting wasn't actually the biggest piece of news out of the meeting.

Matt Frankel: No, it actually wasn't too surprising at all. The market was already pricing in about a 95% chance that this rate hike would happen. We have a recent tailwind with this tax reform, and other positive economic news has made it almost a certainty. So, this may as well have actually happened before it happened. The good news, rather, was the Fed's forecast. The Fed is getting a little more confident about the economy, I guess we'd say. We'll get into the actual numbers in a little bit. But, the Fed is getting a little more confident about the economy and seeing rates in the future going a little higher than they had predicted last time. So, this is the big story.

Douglass: Let's break that down piece by piece. The Fed releases a document that is known as the dot plot four times each year. That basically contains members' projections of where rates are headed over the next few years, basically so that things get priced in. The fact that the market had priced that 95% chance of a Fed rate increase was in large part because of a past dot plot. But let's talk about this one, because things changed.

Frankel: Dot plot is generally a projection of the next three years of interest rates and what the Fed sees happening over the long run. Contrary to popular belief, the Fed does not like to surprise the market. The Fed wants the market to know where it's going and where it sees things going. This one, the numbers went up a little bit from last time. The previous Dot Plot, just to give you some of the numbers, called for rates going to 2.1% this year, which is about where it's going. That hasn't changed much. 2019's target has gone up considerably from 2.7% to 2.9%. In interest rate terms, that's a big shift. 2020 has risen from 3.1% to 3.4%. This means that investors should expect rates to go a little higher than they were previously expecting over the next few years.

Douglass: And I think the big thing for folks thinking about just this year, is, in between 3-4%. That definitely implies a Fed that's getting progressively more hawkish.

Frankel: Yeah. And it's also worth mentioning that the members of the Fed tend to gravitate toward the same rate. There's a lot of agreement on these dot plots. Most are within 50 basis points of each other. There's a few outliers. That's actually one this time that thinks rates going to get to about 5% by 2020, which I actually found one of the more interesting points of the dot plot. But, generally speaking, all the dots are clustered around a consensus interest rate, which is why the market prices in moves like the one we just had so much.

Douglass: Right. And that, in a lot of ways, is a very good thing. The problem with the dot plot is that it's a projection, it's a prediction, and there are weaknesses there. We'll get to that more in a minute. But, it's a really good thing that the market, to some extent, has some expectations about things, because frankly, the market really, really hates uncertainty and even if the certainty is bad, sometimes I think the market prefers that to an uncertain, possibly good outcome. So, in this case, it's a really good way for basically the Fed to not cause a massive reaction every time it moves things, but instead to smooth out that volatility.

Frankel: Yeah, definitely, the whole point of the Fed is to create stable financial markets. That's kind of the whole point of the Dot Plot, they don't want to surprise everybody.

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