Main takeaways:
  • The 25bp cut in the median 'dot' is not compatible with the change in forecasts.
  • This is happening since Sept/14. Blame it on the 'headwinds'.
  • Interestingly, the headwinds have consistently failed to affect Fed's forecasts. They only make their way to the underlying path of equilibrium real rates.


Despite FOMC's dovish statement and remarks, the forecasts for 2016 and 2017 have not changed materially:


Nevertheless, the 'dots' moved down by 25bp across the board. Is it compatible with the forecast revisions?

In order to check this, I have used Yellen's preferred Taylor rule -- the one she mentioned in her speech on Normalizing Monetary Policy.

The chart below plugs Fed forecasts into Yellen's Taylor rule for December 2015. It shows the implied path for interest rates assuming zero real rates (the solid light gray line) and assuming real rates at the long run value forecast by the Fed.

The lines with markers show the median and the trimmed average 'dots'. One can see that the Fed's median forecasts for interest rates at the end of 2015 have been consistent with negative real rates since mid-2013. The average in the period from Jun/13 to Jun/15 was -35bp and the most recent median dot is compatible with real rates at -65bp.


When looking at 2016 forecasts, the picture changes materially. The updated forecasts suggest nothing has materially changed in the Taylor rule range, however the median dot for December 2016 has consistently moved down since September/14. The most recent median dot is compatible with equilibrium real interest rates at -35bp.


The trend for 2017 is similar to 2016: the implied equilibrium real rate moved down by 100bp in the last year (but is currently compatible with equilibrium real rates at +50bp).


The bottom line is: no, the change in the 'dots' is not compatible with the change in forecasts (assuming the reaction function has not changed).

Therefore, the pattern of the last four FOMC dot-plots can only be compatible with the famous 'headwinds' (low oil and commodities, strong dollar, slower global growth) which, interestingly, have consistently failed to affect the forecasts. They only make their way to the underlying path of equilibrium real rates!

The chart below shows the implied Yellen Taylor rule assuming 1.5% real rate (red) and zero real rate (green). The blue dots are the median dot in the Fed's forecast and the chart shows also the fed fund futures the day before the meeting and as of September 18. Markets are skeptical the Fed will be able to follow its own plan (and markets have been right, so far).