The Fed Doth Protest Too Much

Nov 29, 2019 | Nick Scholte


As the QE campaign it denies starting seems to be having a QE-like effect anyway. Also, next week is an especially important week for economic data. We are cautiously optimistic a trough in readings may be confirmed.

To my clients:

It was an up week for North American stock markets with the Canadian TSX rising 0.5%; the U.S. Dow Jones Index rising 0.6%; and the U.S. S&P 500 rising 1.0%.

In my November 8th update, I asserted that economic data may have troughed in the late summer and early autumn. Ostensibly it was the improvement in October readings for both the ISM Manufacturing and ISM Services Indices, combined with employment data that never truly wavered from being solid, that led to this assertion. Sentiment too has been improving, largely aided – one would presume - by improving dialogue between China and the U.S. with respect to the trade dispute. However, I also implied that one month does not make a trend, and one would want to see continued strengthening of these metrics before pushing recessionary concerns to the backburner. With the usual release of these important economic indicators during the first week of a new month, next week will therefore be, in my mind, an especially important time for economic prognosticators as well as the markets. I’m cautiously optimistic.

I’ll preface the following comments by making very clear that the economy is NOT the markets, nor are the markets the economy. However, that they are interrelated and that each tend to concurrently move in the same direction for long stretches of time is self-evident by studying any long-term chart of either. But it is also the case that “the markets” are far more temperamental than the economy upon which they ultimately depend, and it is further the case that the markets are a forecasting mechanism that tends to lead the economy (with, to be sure, a great deal of jittery imprecision in the short-term) by about 6 to 9 months. Likewise, interest rate and related policy adjustments by the U.S. Federal Reserve also tend to have a lagged economic effect of approximately the same 6 to 9 month duration. Why do I bring all of this up? Well, because, in addition to a possible trough in economic data and improved trade sentiment the past month or two, there has also been another development that has likely spurred markets to new record highs – a new quantitative easing (QE) program that the Fed has taken pains to assert is not, in fact, a QE program. But I think that the Fed doth protest too much. In fact, on the website version of my weekly update, I partially titled the October 25th edition “… While the Fed Starts a “It’s Not QE!" QE Campaign”. Quoting directly from that update, I wrote:

The Fed emphasized that the new scheme is “technical” in nature, and was implemented to address issues that popped up about one month ago in the overnight bank lending market. I did not comment upon the matter at the time because the nature of this overnight lending market is very complicated, and frankly I have little knowledge of that area of the market myself. Nonetheless, while the Fed has taken pains to play down its recent bond buying actions, and seems keen to dispel the notion that it has begun yet another iteration of QE, the fact is that the effect is more or less the same. Per one of RBC’s Global Equity Strategists: “improving liquidity conditions on the back of global monetary easing should remain supportive of risk appetite and help shore up the growth outlook for the world economy in the months ahead.”

Since that writing, markets have decisively moved upward. Has this move been attributable to economic data that looks as though it may have troughed – perhaps in response to the leading edge of interest rate cuts (recall the 6 to 9 month lag) begun earlier this year? I’d say partially yes. Has it likewise been attributable to better trade rhetoric? Again, I’d say partially yes. But has it also been attributable to a new variant of QE that, while the Fed asserts it’s not actually a QE program, “the effect is more or less the same”? Yet again, I’d say partially yes.

All the preceding is to say that there is a realistic possibility that recent market strength is anticipatory of economic strength in the months ahead. I’d not yet bet on that outcome (so no equity additions have, as yet, been made), and certainly further confirmation of a trough will be important in next week’s key economic releases. But like I said, I’m cautiously optimistic.

That’s it for this week. All the best,


Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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