The Fed is in a bit of a tough spot with the 2025 dot on the dot plot. It will be introduced for the first time on Wednesday and could run counter to the narrative that they're trying to spin: That they will hold rates high as long as necessary to fight inflation.

Everyone expects to see the end-2022 dot around 4% and the end-2023 dot close to the same level. What happens beyond that may influence tomorrow's market reaction.

Here's the current dot plot, which was released in June.

dot plot

Since then, the Fed has actively and aggressively pushed a 'higher-for-longer' stance. That may push up the 2024 dots but at some point, you need to get back to neutral.

With the 2025 dot, the Fed will very likely be stuck signaling future rate cuts. We could also start to see some 'dissent' in the plot with cuts coming in 2023 and 2024 based on lower growth projections.

A risk is that the Fed signals rates staying high. That would set off a dogfight between the Fed and markets, which are increasingly worried about overtightening and recession.

Further, the bond market is under some heavy strain at the moment and a signal of +4% rates for three years could crack it. BMO offers this today:

On Wednesday, the introduction of 2025 projections will be particularly relevant to the 2s/3s and 2s/5s curves, if for no other reason than investors will have context for whether the Fed believes it can keep terminal in place through 2025. The futures market indicates that won’t be the case and while 2023 terminal has now reached 4.5%, there are still ~50 bp of cuts priced in by the end of next year. Setting aside the Fed’s history of overshooting and quickly reversing course in favor of easing, this is unquestionably a unique cycle and Powell’s rationale for retaining a restrictive stance for an extended period is sound. The unknown is whether the real economy can handle such policy extremes and how much excess demand destruction Powell is willing to risk.