In a primeval forest, a map and compass can be lifelines to help adventurers find the right direction.

Likewise, in a complex economic society, people also need a direction they can refer to.

For example, it may be an outlook on the Fed funds rate.

The Fed funds rate is an important short-term rate that can affect loan costs and savings interest rates in the US.

As a result, people keep a close eye on a chart that predicts the Fed funds rate, which is known as the Fed dot plot.

Now let's take a trip back to 2012.

Back then, the US economy was still recovering from the 2008 financial crisis.

The interest rate was near zero,

and the markets had no clue about when it might go up.

Then the Fed decided to have more policy transparency which could in turn help to set market expectations.

Out of this idea, the Fed dot plot was born.

Now, the dot plot is released quarterly in the Summary of Economic Projections.

What does the dot plot say?

We can interpret this chart from three dimensions.

● First, let's start with the basics.

The X-axis indicates a time period spanning from the current year to the next three years or a longer term.

The Y-axis represents the federal funds rate.

Each dot marks where an FOMC (Federal Open Market Committee) member expects the Fed funds rate to be.

Generally, the FOMC consists of 7 members of the Board of Governors of the Fed,

and presidents of the Fed's 12 district banks, including those without a vote on adjusting the interest rate of the current year.

That being said, the actual number of dots may be less than 19 when there are vacancies.

● Second, we can look at the most concentrated dots and the median of the dots.

Let's take this year as an example.

Most FOMC members forecast that the federal funds rate will be between 4.0% to 4.5%.

And people's focus is usually put on the median of the dots,

as it often represents the closest Fed policy direction.

If there are 19 dots, the 10th dot from the bottom upward tends to be vital.

When the number of FOMC projections is even, the median should be the average of the two projections in the middle.

A longer-run median is also referred to as the "neutral rate of interest".

A neutral rate indicates that it may neither stimulate nor restrict economic growth.

At this rate level, the economy could achieve maximum employment and price stability.

● Third, we can try to spot the changes and movements.

Investors and economists may compare the latest dot plot with the last one released to find out whether the FOMC's attitude has changed.

A dot plot could also show the potential economic path in the future.

This chart shows that the Fed may raise interest rates next year and lower interest rates two years and three years from now.

Besides, a series of densely arranged dots indicate a degree of consensus among FOMC members.

Conversely, scattered dots tell us that the members hold different opinions, and rate changes may be greater in the future.

Is the dot plot trustworthy?

Although people closely follow the dot plot chart, many experts, including Fed members, doubt its accuracy.

Why? Because the economy is too complex and uncertain to be precisely predicted.

Fed officials' forecasts are never set in stone.

As information about the economy shifts and the FOMC membership changes, their attitude may change.

But the disclosure of the dot plot can't be up-to-date.

For instance, the December 2019 FOMC dot plot indicated no rate changes in 2020.

However, the Fed lowered the rate to nearly zero in the year due to the outbreak of COVID-19.

To conclude, the dot plot may offer some clues if you want to learn where interest rates may head.

However, a more thoughtful practice would be to consider more factors when it comes to investment decisions rather than simply relying on a chart.