Even the FED itself cannot predict the future of interest rates!

Markets continue to price the possibility of a rate cut, but historical data show that even the Fed itself cannot predict how interest rates will trend in the next year. Historical data shows that even the Fed itself cannot really predict what it will do with interest rates a year from now.

Failure to predict even one year ahead For the second day in a row, financial markets continue to absorb that perhaps the world's most powerful central bank appears poised to cut interest rates from 22-year highs starting in 2024, reports Vivien Lou Chen for MarketWatch. But historical data suggests Fed policymakers may remain as in the dark as anyone about what they will actually do beyond a three-month period.

According to an analysis by Glenmede Investment Management, the Fed's interest rate projections between 2012 and 2023, known as the 'dot plot', may only be an accurate method of predicting where the Fed funds rate target will be in a relatively short period of time. According to a study by Alex Atanasiu, Portfolio Manager at Glenmede, the Fed's dot plot projections are relatively 'less accurate' when measuring where borrowing costs will end up next year and 'surprisingly inaccurate' when looking two years ahead.

Atanasiu uses September as the starting point for the analysis, as the Fed's dot plot reflects the level of interest rates that officials think will be appropriate by the end of the year for each of the next few years. The result suggests that the dots are only accurate in predicting where interest rates will be in December of the same year because policymakers are unlikely to change course significantly in such a short period of time.

Treasury yields fall sharply, stock markets continue to rise At the centre of the financial markets' reaction to the Fed's surprisingly dovish policy update is also the significant drop in Treasury yields, which continued to set the tone for the rest of the markets on Thursday. After the continued decline in Treasury yields, the policy-sensitive 2-year Treasury bond yield and 10-year Treasury bond yield fell by 8 basis points and 10.3 basis points to almost 4.4 per cent and 3.9 per cent, respectively, returning to the levels of June-July. The rise continues in the three major stock market indices. While the Dow Jones closed with a record closing of 37,248.35, the US Dollar Index fell by 0.9 per cent. Meanwhile, Fed funds futures traders caught the Fed's dovish stance and moved with it. They are currently pricing in an 87.3 per cent chance that the central bank will cut its policy rate by more than three rate cuts by next December, in line with the Fed's forecasts. Oil prices may get a nasty surprise Michael Reynolds, Glenmede's vice president of investment strategy, said: "We think there is still a bit of a gap between the amount of interest rate cuts the markets are expecting and what the Fed is telling us. The Fed is preparing us for a Goldilocks scenario where nothing else can get in the way. But history shows that some things come out of nowhere and disrupt things along the way," he said, underlining their caution. Referring to various 'unknown unknowns' over the past two years, such as the onset of the US Covid-19 pandemic and supply chain disruptions following Russia's invasion of Ukraine, Reynolds says the biggest ongoing risk is what will happen to oil prices, which could give investors a 'nasty surprise' if oil prices suddenly rise. Uncertainty about interest rates is high "Time will tell what the appropriate level for interest rates actually is, but the market and the Fed may be out of their depth. "No one can be a perfect forecaster or arbiter of where interest rates will go, and the conclusion here is that there could be fewer or more than three rate cuts in 2024. People tend to take the Fed at its word, but there is a lot of uncertainty," he said.