There’s Only One Dot That Matters Now

One of the most scrutinized reports to come out of Federal Open Market Committee meetings is the infamous “dot plot”—a chart that depicts what each committee member anticipates for the future direction of short-term interest rates. There are 17 members on the FOMC, and if all seats are occupied there are 17 dots—all of them anonymous—showing the distribution of opinions on where the overnight lending rate is headed based on economic indicators such as gross domestic product (GDP), employment, inflation, etc. The range from low to high has been pretty tight since the overnight rate has failed to pierce the 2.50 percent threshold since 2008.

Rates Are in a Tight Spot

Right now, with the economy in a recession, the outlook is much clearer. In fact, the dot plot has simply become one large dot representing that every FOMC member believes the overnight interest rate is going to stay in the zero to 0.25 percent range for the rest of 2020 and all of 2021. Consensus among the committee is rare, but given the COVID-19 lock on the U.S. economy, it’s pretty clear the overnight lending rate is not budging anytime soon.

The last time the Federal Reserve lowered the overnight interest rate to 0–0.25 percent was during the Great Recession, and it stayed there from December 2008 through December 2015. That seven-year span is how long it took the economy to start expanding consistently enough to warrant the Fed raising its key rate. The big question now is, “How long will it be before they act again?”

What’s the New Normal Rate?

The answer is not so easy given the current trajectory, but once the economy appears to be on stable ground and growing, keep an eye out for the Fed to begin to winding down the special liquidity programs it implemented. When that starts to happen, you can expect the Fed to start raising the overnight rate soon after. Will it be seven years? Probably not, given the quick action by the federal government and Reserve to prop up the U.S. economy. GDP growth is expected to be anemic for the next two years, so it is very unlikely the Fed will alter course.

As for the long-run, British Economist John Maynard Keynes once stated, “In the long-run we are all dead.” However, in this case the Fed does have a long-run overnight target it will aim for as the economy picks up steam. That neutral, long-term rate is 2.50 percent, which is also a new normal as it used to be 5 percent “back in the day.” Why the difference? Two recessions in the last 12 years and an economy severely hammered by an unrelenting pandemic that still has its grip on the American public.