The Looming ‘Dot Plot’ Disconnect

Stocks have enjoyed a spirited rally in recent weeks fueled by diminishing credit market stress and economic data that’s been getting “less bad,” as I pointed out last week.

The S&P 500 Index jumped 9.5% from the mid-February low as of last night’s close. That’s a sizable rebound that has investors wondering whether the bottom is in, or if this is just another bear-market trap poised to spring on unwary investors.

While the outcome is still uncertain, one factor that has me worried is the growing disconnect between the Federal Reserve’s interest-rate policy intentions and Wall Street’s expectations.

Ever since the Fed began the process of “normalizing” interest rates by hiking the Fed funds rate 0.25% in December, investors have been busy handicapping the likely path of future rate hikes. With every piece of economic data, good or bad, interest-rate forecasts rise or fall.

For its part, the Fed has largely stayed on course since raising rates three months ago. The Fed’s infamous “dot plot” published after the December policy meeting indicated four more quarter-point increases in the Fed funds rate by the end of this year, with benchmark rates rising to 1.375% by the end of this year.

But Wall Street isn’t buying it.

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A recent survey of economists called for just two rate increases in 2016, with no better than a 50% chance that the next hike would come before November. Rate increases at next week’s Fed meeting and the next in June are considered low-probability if not off-the-table altogether.

And market-based expectations for the path of interest rates are even more benign.

As recently as mid-February, fed funds futures markets were pricing in only an 11% chance of even a single rate hike anytime this year. After last week’s better-than-expected jobs report, those odds increased slightly, but markets are still pricing just a 50/50 chance of a Fed rate hike before September.

That’s a long way away, and there are four more Fed policy meetings (including next week’s) between now and then.

This is a giant disconnect between market perception and Fed reality. And it could easily derail this rally if the Fed unexpectedly hikes rates sooner, and the markets throw another temper-tantrum as a result.

Currently there is a zero percent chance of an interest-rate increase at next week’s Fed meeting, but there could be plenty of drama contained in the Fed’s revised outlook and forecast for the future path of rate hikes.

Beware the ides of March, and next week’s plot of the dots.

Good investing,

Mike Burnick

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Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.