What The Twitter “Dots” Are Telling Us About Interest Rate Hikes by David Schawel, Economic Musings
Right now the market is obsessed with figuring out if and when the Fed is going to raise interest rates. Rate participants closely watch the Fed’s “dot plot” which shows the midpoint of the target range for the fed funds rate by year. The March dot plot released shows the end of 2016 with a median of 1.75% and the end of 2017 at 3.125% – both lower than the projections released in December. Even after this downward revision a large difference exists versus the market as futures are pricing in substantially lower rates than the dots indicate.
Enter the Twitter fed funds survey in which I asked followers to tell me where Fed Funds will be three years from today. 135 responses were used after trimming the highest and lowest three answers. The survey results are very close to what March 2018 Eurodollar futures (H8 contract) is pricing. More interesting though is the distribution and what it might be telling us about the different schools of thought.
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Aside from a fun exercise, I hoped this survey would shed some light on the differences of how the market is viewing rates going forward versus the Fed. Here are a few things it might be telling us:
- There appears to be two very distinct ideological camps in the responses. Roughly 20% of respondents see fed funds at or below 0.25% in three years while 35% see rates at or above 2.50%. The mean & median were both ~1.75% but the largest amount of responses were elsewhere – and the composition tells us important things.
On one hand you have the everything is going back to “normal” camp where participants likely point to month after month of strong employment gains, encouraging underlying trends of income gains, and inflation muted by commodity driven disinflationary pressures.
The other camp likely believes some or all of the following: the Fed will be unable to raise rates while maintaining stability, we’re in a period of secular stagnation, international factors take a rate hike off the table, and the natural real rate of interest is now much lower than pre-crisis.
- One faction of market respondents will be proven to be wrong and this could be painful for them. Pricing assets assuming multiple years of zero interest rates when 3-4% materializes would be a big miss. Similarly, it’s conceivable that macro bulls could throw in the towel with another year of rates grinding here and the Fed unable to lift off. Both groups can’t be right.
- There’s likely a recency bias: The pendulum swings quickly among Fed prognosticators. In mid January among plunging oil and European problems we saw 2y USTs fall to 0.40% and a June rate hike seemed unfathomable (yes, I said that too). Then in early March a huge payroll report sent 2y USTs above 0.70% and suddenly a June hike was a lock. Now only a few weeks later we have Fed minutes that show a lower GDP forecast without a 3% handle in sight, along with a lower “dot plot” as described above. The worry du jour today is the strengthening US dollar and the Fed’s relative tightening versus other central bank’s who have the pedal down. Whichever camp you’re in, it pays to remember how short of a memory the market has with respect to this topic.