One of the most common questions we’ve fielded throughout the last year or so is some variation of what do you think the Fed is going to do? or where are interest rates going? Interest rates, interest rates, interest rates. People are more interested in a press conference given by the Chairman of the Federal Reserve than the President of the Untied States. Meet someone at a party and it’s a coin flip whether college football, Taylor Swift, or mortgage rates comes up first in conversation. We live in interesting times.
We have watched pundits and professionals – some directly others only tangentially tied to the finance business – pontificate on interest rates since they became the topic du jour. Some think interest rates will keep going higher. Others think the terminal rate has already arrived. Still others see significant rate cuts around the corner. The only similarity is the aura of certainty with which they each deliver their remarks.
For background, the Federal Open Market Committee (FOMC) of the Federal Reserve sets the federal funds rate – the interest rate everyone is referring to and the most important rate in the economy. If you’re financing something, your lender is offering you an interest rate in some way influenced by the federal funds rate. If the fed funds rate is high, your mortgage rate or car loan or whatever other rate is going to be high. If fed funds are close to zero, you might be able to get one of those sweet 3% mortgages everyone got a few years ago that have suddenly disappeared. The FOMC holds eight meetings each year, and after four of them (the last month of each calendar quarter) they release the famous (infamous?) dot plot. Here is the dot plot released in December ’21:[i]
Think back to December ’21. The stock market was at an all-time high – up 116% from the 2020 pandemic lows.[ii] Inflation came in at 4.7% in 2021, far beneath the scorching 8.0% in 2022 but much higher than the tame 1.2% reading in 2020.[iii] Bitcoin reached an all-time high of over $67,000 in November – up 1,280% from the 2020 lows.[iv] The 30-year mortgage spent the last two years hovering in the 3% range.[v] Most Americans couldn’t find Ukraine on a map.
Each dot on the dot plot represents each Fed official’s prediction of the federal funds rate at the end of each of the next four years as well as the amorphous “longer run.” The Fed officials whose predictions those dots represent – and I can’t emphasize this enough – are the very people who decide the federal funds rate each year. The actual federal funds rate is a range, typically separated by about 25bps. Looking at the dot plot above, you can see everyone was in agreement about the range of the federal funds rate being 0-0.25% at the end of 2021, because the plot was released in December ’21. Those dots were merely a reflection of the current federal funds rate. Things get a bit interesting looking at Fed officials’ predictions for rates at the end of 2022. The most hawkish (hawk = higher rates) predicted rate hikes of 100 basis points (100 basis points (bps) = 1%) to 1% - 1.25% by the end of 2022, while the most dovish (dove = lower rates) predicted rates would only rise 25 bps to 0.25% - 0.5% by the end of the year.
If you’re reading this blog, you probably (hopefully) don’t obsessively follow interest rate policy, but at this point perhaps you’re muttering to yourself something along the lines of hmm it seems like interest rates were quite a bit higher by the end of last year or you’re telling me the HAWKS in Dec. ’21 only expected 100bps of rate hikes?!
That is the right line of thinking. Here is the actual path of interest rates in 2022 (this chart is shows the upper limit of the fed funds rate range):[vi]
For those keeping score, that adds up to 425 bps of rate hikes in 2022 when the median forecast just a year previously made by the people who implemented those 425 bps of rate hikes themselves was about 100 bps.
Yet pundits and financial advisors and mortgage brokers and all sort of people will eagerly sell their own interest rate forecasts to the public. Even though THE PEOPLE WHO DETERMINE INTEREST RATES THEMSELVES HAVE NO IDEA WHERE RATES WILL BE A YEAR FROM NOW AND THIS FACT IS PUBLIC RECORD AND RELEASED ON A QUARTELRY BASIS. I mean, come on.
The Fed started the latest rate hiking cycle in March of ’22. Here is the dot plot they released then:
Perhaps a bit better, but not much? At the extremes, one hawk in March expected rates to get up to 3.25% by the end of the year while one dove expected only to get to 1.5% with a median projection of 2%. The lone hawk was way off and the median forecast wasn’t even in the ballpark. For context regarding the 2023 dots, the upper range of the federal funds rate is 5.5% as of October ’23.[vii] As usual, Fed officials’ predictions of 2023 rates made in March ’22 turned out useless.
So if interest rate predictions entered into the official record by the individuals who themselves set interest rates are useless, how useless is an interest rate forecast made by anyone else? Why waste one iota of mental energy considering what some other person/bank/firm/whomever says about where interest rates are heading? You would be better suited guessing sea levels next year. At least you could bail a little water out of the ocean to exert some infinitesimal influence. The pundits speculating on future interest rate policy know less of interest rate levels next year than a man frantically bailing water out of the Atlantic Ocean knows about prospective sea levels.
Sean Cawley, CFP®
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[ii] YCharts, Fundamental Charts, SPX Total Return Level, 03/23/2020 – 12/15/2021.
[iv] YCharts, Fundamental Charts, Bitcoin Price, 03/11/2020 – 11/09/2021.
[v] YCharts, Fundamental Charts, 30-Year Mortgage Rate, 01/01/2020 – 12/15/2021.
[vi] YCharts, Fundamental Charts, Target Federal Funds Rate Upper Limit, 01/01/2022 – 12/31/2022.
[vii] YCharts, Fundamental Charts, Target Federal Funds Rate Upper Limit, 01/01/2023 – 10/26/2023.