Wednesday, July 9, 2014

The "Dots Explained

Much has been made of the “dots”, the pretty smattering of the FOMC voting members depicting their Fed Fund expectations to 2016 and then for the “Long Run” thereafter.  The tabling of these expectations are potent as they show the FOMC voters true thoughts no matter the verbiage of the Minutes or the Statement prior.  A voting FOMC member can now dissent  anonymously without casting a dissenting vote, providing subtle and yet more powerful contrary views.  Finally, in the “Long Run” Fed Funds expectations,  the Keynesian steeped FOMC members – no matter if a classic Taylor like view or a New Keynesian  “forward guidance”  believer – all agree Fed Funds converge to NGDP.  So much can be expressed in the ‘Dots” without knocking heads against Chairman Yellen directly, or entering into a weary argument, once again, with the likes of President Kocherlakota or Secretary English.  The “true believers” are onto this form of sneaky dissension and have even started a move to ban the “Dots” forcing  dissenters into a publically noticed “no” vote.   But for now we still have the ‘Dots”. It is obvious the "1%" expectation FOMC voter does not believe in a single word of both the Minutes and the prior Statement. 

The “Dots” as almost all wrestle with to date are here:

Very pretty  indeed, and then most cut and paste several of these FOMC charts on top of each other, holding them up to a bright light, to get an idea how they change.

A better way to consider the “Dots” is via the famous statistician John Tukey's “box plot”, with each column above represented by a “box and whisker”.  The line bisecting the box (sometimes it doesn't bisect if the expectations are extremely skewed) is the median value, the top and bottom of the box is the 75th and 25th quartile boundary and the dotted line goes out to the 100%  but for extreme trimmed outliers which are shown well above or below the box.  Those are our “secret dissenters”.  A  set of boxplots are plotted for the Dec 2013, Mar 2014 and the June 2014 FOMC package attached to the minutes.  And here it is:

A lot easier to track the “secret dissenters” and the range of the calls and the median of those calls which most see as the “Fed Funds “ path as if it is written on a tablet from the mountain.  There is obviously much turmoil at the FOMC hiding behind the tepid minutes written by the “true believer” Secretary Bill English to suit the Chair’s supposedly all-encompassing view.  To my read it looks like the FOMC consensus is now a facade of sorts and there are some serious mischief makers armed with their large credible staffers back at the regional FRB office tower.  Then there are some technical issues of note – first extreme disconnect for the majority of the FOMC who feel a very large 1% rise in the Fed Funds will be required – hopefully not all on the last day of 2015 as the Chairman suggests. Then the majority believe another wrenching very large 1.5% add on to Fed Funds are required in 2016.  Given the size of these expectations of the FOMC majority, and taking into account past FOMC tightening, most of this 2.5% raise will happen swiftly, likely within 6 months or even shorter.  The next interesting point is that the Long Run consensus is very tight around 3 ¾%, but that has dropped from 4% recently.  This shows the entire FOMC is a believer in the “New Normal” of Bill Gross, just not as much a drop that he anticipates from the “Normal” long run NGDP.  And a significant change in this belief to even a more pessimistic view occurred in the three months between March 2014 and June 2014.  Why?  Yet at the same time the expectations for growth or return to trend growth accelerated from the March FOMC meeting to the June, as shown by increases by the majority of FOMC voting members for 2015 and 2016.   No wonder the  curve flattened so much in 1st Q to 2nd Q 2014.  The dispersion  increased in the June meeting for both 2015 and 2016, suggesting greatly increased volatility is implicitly expected by the FOMC voting members.  VIX shorts  should take note.

This shows the basis point vol as reflected in the dispersion of the FOMC voters:

The move from 0.78 yield vol to 1.26 for 2016 Fed Fund call in the June FOMC will likely result in about a 2% 2 year vol at some point which will be wrenching and perhaps transmit to a 25% VIX and 2 year SP vol swap.

The voting members of the FOMC “Dots” should be taken in very carefully with a few caveats. The first, though with exceptional knowledge, experience and insight, is that these are human expectations and the wide differences  between the members shows clearly the lack of consensus, despite the unanimous vote.  And those expectations, already diverse,  always change with a “whoosh”.  The second point, on that “whoosh”, is well described by Mike Tyson; “everyone has a plan until they are punched in the face”.  

Or to paraphrase; “Expectations from the FOMC are reliable until they change, suddenly.” 

The “Dots” should also be seen as the tip of an iceberg where each “dot” is backed by a army of researchers and the credentialed, who are without a doubt the best in the world at monetary policy and monetary economics.  Each “dot” represents thousands of hours of research and debate, sometimes intense debate to the point careers are ruined, or then rescued as Kehoe was at the Minneapolis FRB.  So each “dot” is the end results of the very complex political demands of each voter to their home base, and is a melding of their staffers views and their own.  At the very least the voter is required to spend hours upon hours consulting and interacting with the staffers even if the voter's personal view is different.  That is unless you are President Kocherlakota in which case you simply fire the bastards.