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Don’t Listen To What The Fed Says

rates increaseFed chair Janet Yellen this week reaffirmed why we shouldn’t pay attention to what the Federal Reserve says when it comes to interest rates.

Three months ago, the Fed’s rate-setting committee muddled the timeline for when it will boost short-term rates.

It replaced measurable targets with squishy language suggesting rates would remain unchanged “for a considerable time” after the Fed stops its other effort to prop up the economy — buying tens of billions of dollars a month in Treasury securities and mortgage-backed bonds.

Yellen appeared to clear this up a bit when she clarified during a news conference what “a considerable time” might mean: She said barring bad inflation or employment news, short-term rates could increase six months after the Fed stops its asset purchases. The central bank is in line to end those purchases sometime this fall.

But this week Yellen walked back the six-month target.

“There is no mechanical formula whatsoever for what a ‘considerable time’ means,” she said at her latest news conference following a Federal Open Market Committee meeting, adding, “It depends on how the economy progresses.”

You can’t trust what Fed officials say one day, because they might say something completely different the next.

So, we’re back to the blue dots.

Here’s a quick summary of what we mean:

A blue dot on the documents released following each Fed meeting (like the one this week) represents a vote of sorts from individual officials. They’re predicting, as it were, where the federal funds rate could be set at the end of a particular year.

The federal funds rate is the short-term bank-to-bank lending charge the central bank sets. It influences all sorts of other yields, including those on savings accounts and certificates of deposit.

The federal funds rate has been set near zero since late 2008. Savers won’t be able to earn a decent return until the Fed significantly boosts this rate.

Here’s what the blue dots look like:

Blue dots from the Federal Reserve

Each dot on the chart above shows where individual committee members believe the rate is likely to be at the end of 2015 and 2016 and what the expected long-run average should be.

And here’s a chart that shows how Fed thinking has evolved over time. It shows there has long been a consensus that the first rate increase will occur next year, even if the Fed hasn’t always explicitly said so:

Chart showing how Fed rate hike predictions have changed

In one area, Yellen has been quite clear — she hopes you don’t put too much stock in the dots. But since March, we’ve advocated just the opposite. And we’re not alone.

Marketwatch.com senior reporter Greg Robb wrote “the dots matter most to investors” because it shows what the Fed is thinking, not what its leaders are saying.

From the story:

“Mike Moran, chief economist at Daiwa Capital Markets, said Yellen’s protest about the dot plot was ‘180 degrees from accurate.’

” ‘Changes in the plot from meeting to meeting show how the views of the Fed are evolving,’ he said.

“In contrast, the Fed’s policy statement is now deliberately ‘just vague’ about the factors that will prompt the first rate hike, so as to gain support from various factions of Fed officials, he said.”

Watch the dots. Ignore the noise.

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Comments (2)
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  1. ron said:
    on June 20th at 11:51 am

    Define “longer run.”

  2. Mike Cetera said:
    on June 20th at 02:11 pm

    Ron: For the purpose of inflation and unemployment, the Fed defines “longer run” as “in five or six years.” I imagine this is their definition as it pertains to the federal funds rate, as well.