With the release of its economic forecasts and, more importantly, its dot plot of future rate increases, the Fed is asking investors to “trust us, we know what we are doing”. Whether we should expect 2 or 3 rate hikes in 2018, is beside the point. We are asked to ignore current conditions and take a leap of faith that the economic conditions through to 2020 will warrant a steady drumbeat of rate increases, probably ending with a fed funds rate that is the vicinity of 3.5 per cent by 2020.

The Fed’s uses its dot plot to map out the future. Each dot represents a member’s view on the fed funds rate each year. The central tendency among the bankers is a federal funds rate of 2.9 percent by the end of 2019, implying three rate increases next year, compared with just two moves seen in the last round of forecasts in December. They anticipate that rates will hit 3.5 percent in 2020, up from 3.1 percent earlier in December, according to the median estimate (Figure 1). What lies behind this upgraded forecast?

Overall, FMOC members are buoyed by their own forecasts for economic growth over this time period (Figure 2). Compared to the December forecast, the FOMC’s March forecast calls for a substantial boost in the outlook for 2018 from 2.1 per cent to 2.6 per cent; for 2019 from 2.0 per cent to 2.3 per cent; and for 2020  from 1.8 per cent to 2 per cent. Everything is coming up roses.

But what about the present conditions and how are they going to influence this outlook? The Fed seems to gloss over present conditions and events while painting this rosy outlook. Some of the most important developments affecting future inflation and growth are manifest in today’s data. Consider these developments and what they tell us about the outlook for inflation, the key economic measure used to influence rates:

• Wage growth, despite all the protestations of the Phillips curve’s adherents, remains subdued and has not had any real impact on current inflation or inflationary expectations.; in fact, the term premium on long-term bonds has reversed course and is heady further into negative territory;
• Industrial commodity prices are weak and have been on a downward trend, in large measure because of excess capacity worldwide.
• Major agricultural products continue to remain weak, in the face of production surpluses; the prospects of a full-blown trade war with China now threatens to depress farm prices even further;
• An international trade war is highly deflationary in the sense that economic growth slows as domestic consumers are faced with higher prices on essential imports; and
• As the U.S. Federal government floods the credit market with record-breaking volumes of Treasuries, medium to long-term bond yields will be under pressure, exacerbating interest rate payments as fiscal deficits eat up more of tax revenues.

Given this weak starting point, it will be a real challenge for the U.S. economy to reach the future as mapped out by the Fed.