On September 20, 2023, the US Federal Reserve released the updated Fed dot plot, which showed a projected 2.7-point interest rate cut by year-end 2026. The 19 FOMC participants also projected PCE inflation to fall from 3.3% at year-end 2023 to 2.2% at year-end 2025 and for the unemployment rate to rise slightly, from 3.8% to 4.1%.
This fixed income blog post covers the key takeaways from the September 2023 Summary of Economic Projections report (the "SEP") and how investors can use it to enhance investment performance.
- The median of the September 2023 Fed dot plot projects the fed funds rate to fall from 5.6% at year-end 2023 to 3.9% by year-end 2025
- The Fed dot plot then projects the fed funds rate to fall to 2.9% by year-end 2026 and 2.5% in the "longer run"
- The September 2023 Fed dot plot is more hawkish than the June 2023 dot plot, as the median fed funds rate projections for 2024 and 2025 were 0.5 percentage points (or 50 "basis points") higher
- All multi-year projections must be taken with a grain of salt; however, the FOMC participants seem to have broad agreement on a 2.25-2.75% long-run fed funds rate should inflation stabilize at 2%
- We encourage investors to consider the Fed dot plot in the context of the other economic projections provided by the FOMC participants
- While certain high quality short term corporate bonds should perform well over the near term, the current environment provides investors opportunities to increase duration to lock in higher interest rates for longer and to achieve long-term capital appreciation
The September 2023 Fed Dot Plot
The 19 FOMC participants include seven members of the Federal Reserve Board of Governors and the presidents of the 12
Federal Reserve Banks. In the Fed dot plot, each dot represents a participant's "judgment of the midpoint for the
federal funds rate." Note that, at each FOMC meeting, only 12 of the 19 participants have a vote on setting the fed
funds target rate.
What Does the September 2023 Dot Plot Say?
With the Fed leaving rates unchanged on September 20, 2023, the current target range for the fed funds rate is 5.25%-5.50%. As shown in Figure 1, 12 FOMC participants believed the target rate should be 5.50%-5.75% at year-end (a 25-basis-point hike), while seven believed the rate should hold steady at current levels.
Views of FOMC participants diverge more in 2024 and 2025. In 2025, the range of target rates is from 2.50%-4.25% on
the low end to 4.50%-5.75% on the high end. The median 2025 fed funds rate projection is 3.9%, a 1.7-point fall from
the 5.6% median for year-end 2023.
Figure 1: September 2023 Fed Dot Plot of the Projected Year-End Fed Funds Rate
Source: FOMC September 2023 Summary of Economic Projections
In 2026, there's a noticeable split between the hawkish and dovish wings of the FOMC. In this year, six participants believed a range of 3.75-5.00% would be appropriate, whereas 13 participants believed the target rate should be between 2.25%-3.25%.
The Fed dot plot is updated quarterly, and these projections can and will change based on where FOMC participants believe they are in accomplishing the Fed's dual mandate of price stability and full employment.
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How the September 2023 Fed Dot Plot Compares to the June 2023 Fed Dot Plot
While the FOMC will hold eight meetings during 2023, the Fed dot plot is only updated each quarter and released as part of the SEP. The September 2023 Fed dot plot is slightly more hawkish in 2024 and 2025, as the median fed funds target rates have increased 0.5 percentage points (or 50 "basis points") compared to the June 2023 Fed dot plot, shown in Figure 2.
For example, the median 2025 fed funds target rates were 3.9% and 3.4% in the September 2023 Fed dot plot and June 2023 Fed dot plot, respectively.
When you hear various talking heads say they expect the fed funds rate to "remain higher for longer," this is to which they are referring.
Figure 2: June 2023 Fed Dot Plot of the Projected Fed Funds Rate
Source: FOMC June 2023 Summary of Economic Projections
The Fed's Rationale for Keeping Interest Rates "Higher for Longer"
In addition to containing the Fed dot plot, the SEP report contains FOMC participants' estimates of unemployment, PCE inflation, and GDP growth. Figure 3 shows the FOMC participant economic projections released during the September 2023, June 2023, December 2022, and March 2022 SEP reports.
Figure 3: FOMC Participant Median Estimates of Year-End Unemployment, PCE Inflation, and GDP Growth
| Date of Projection | 2022 | 2023 | 2024 | 2025 | Longer Run |
| Unemployment Rate | |||||
| Sept 2023 | NA | 3.8% | 4.1% | 4.1% | 4.0% |
| June 2023 | NA | 4.1% | 4.5% | 4.5% | 4.0% |
| Dec 2022 | NA | 4.6% | 4.6% | 4.5% | 4.0% |
| Mar 2022 | 3.5% | 3.5% | 3.6% | NA | 4.0% |
| PCE Inflation | |||||
| Sept 2023 | NA | 3.3% | 2.5% | 2.2% | 2.0% |
| June 2023 | NA | 3.2% | 2.5% | 2.1% | 2.0% |
| Dec 2022 | NA | 3.1% | 2.5% | 2.1% | 2.0% |
| Mar 2022 | 4.3% | 2.7% | 2.3% | NA | 2.0% |
| Change in Real GDP | |||||
| Sept 2023 | NA | 2.1% | 1.5% | 1.8% | 1.8% |
| June 2023 | NA | 1.0% | 1.1% | 1.8% |
1.8% |
| Dec 2022 | NA | 0.5% | 1.6% | 1.8% | 1.8% |
| Mar 2022 | 2.8% | 2.2% | 2.0% | NA | 1.8% |
Source: FOMC Summary of Economic Projections Reports
Unemployment in 2023 has been lower and GDP growth materially higher than the Fed believed they would be in December
2022. Since the economy has 'come in hotter' than expected, the Fed believes it needs to hold interest rates at a
'restrictive level' to ensure inflation returns to the Fed's 2.0% target for a sustained period.
PCE inflation (also known as the Personal Consumption Expenditures Index) is the Fed's preferred gauge of price movements in the US economy. As shown in Figure 3, projections for 2024 onward PCE inflation haven't changed much since December 2022. Moving back to the March 2022 SEP Report, however, we see the FOMC participants were projecting 4.3% and 2.7% PCE inflation for year-end 2022 and 2023, respectively.
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December 2022 PCE inflation came in at 5.0% compared to the FOMC's 4.3% median projection. While the 2.7% PCE inflation the Fed projected for year-end 2023 in March 2022 is within earshot of the 3.3% projection made September 2023, the Fed's miscalculation was the level of interest rates required to bring PCE inflation to that level.
As shown in Figure 4, in the March 2022 Fed dot plot, the median projection for the fed funds rate was 2.8% at year-end 2023 and 2024 vs. the 5.6% and 5.1% median fed funds rate projections made in the September 2023 Fed dot plot:
Figure 4: March 2022 Fed Dot Plot of the Projected Fed Funds Rate
Source: FOMC March 2022 Summary of Economic Projections
What the Fed Dot Plot Means for Investors
PCE inflation hit a post-pandemic peak of 6.8% in June 2022 and fell to 3.3% in July 2023. While this fall is significant, the Fed will not rest until inflation reaches 2.0% for a sustained period. We encourage any doubters to watch Chair Powell's post-FOMC-meeting pressers, which have reiterated this point ad nauseam.
As we have seen, the Fed dot plot is not perfect at predicting the future fed funds rate. That said, what we find most useful is the view of FOMC participants on the appropriate level of interest rates across different economic assumptions.
Across all three Fed dot plots shown in this fixed income blog post, the longer-run projections have been inflation of 2.0% and a fed funds rate of approximately 2.50%. This longer-run fed funds rate is three percentage points below the upper end of the current 5.25-5.50% fed funds target range.
Given the stickiness of inflation and the Fed's recent hawkish stance, it is likely for short-term interest rates to remain above 5% through 2024, which could keep money market fund returns elevated. The question investors must ask themselves, however, is how to position themselves beyond 2024.
As we discuss in our Eight Reasons Not To Own Vanguard VMFXX blog post, the VMFXX yield is highly correlated to the fed funds rate. As the fed funds rate falls, we would expect the VMFXX yield to fall as well. In addition, since money market funds such as Vanguard VMFXX cannot achieve capital appreciation, such investments would not benefit from an increase in bond prices associated with falling interest rates.
In our VMFXX yield blog post, we discuss how US Treasurys and high quality US corporate bonds have advantages to Vanguard VMFXX, including higher potential returns, lower fees, and higher credit quality. While a 10- or 20-year corporate bond and a money market fund are different investments, investors may want to consider adding to their corporate bond exposure to take advantage of falling interest rates when they occur. These investments allow investors to lock in interest rates for a longer period than money market funds and to benefit from capital appreciation opportunities in the event interest rates fall.
