The Federal Reserve Confirms A Significant Change to Policy

Aug 28, 2020 | Nick Scholte


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By targeting "average inflation", the Fed signals that rates will remain low for an extended period; meanwhile, the "7-day delta" might be signaling an imminent move higher in U.S. covid cases - probably the result of U.S. college re-openings.

To my clients:

It was an up week for North American stock markets with the Canadian TSX finishing up 1.1%; the U.S. Dow Jones Index finishing up 2.6%; and the U.S. S&P 500 finishing up 3.3%.

Well, the surgery is done and, though I think it went well, I vastly underestimated the recovery. It’s been an uncomfortable and foggy week. As such, this week will be a short update with just two brief observations:

1) At the annual Jackson Hole symposium, Federal Reserve Chairman Jerome Powell announced that the Fed will be transitioning to a new policy of targeting an “average” inflation rate. Effectively, what this means is that the Fed will allow rates to overshoot its 2% inflation target such that the time inflation spends above 2% and below 2% averages out to right around 2% (in theory anyway). Prior, the Fed would raise rates to slow inflation any time inflation appeared to be approaching the 2% target. By allowing inflation to overshoot 2%, this is another signal from the Federal Reserve that interest rates will remain low for quite some time. This development is supportive of equities (stocks); and

2) Covid cases may be on the cusp of another turn higher. Recall that after the initial spike in March and April, U.S.covid cases declined on a national basis before surging to new highs in June and July. Thereafter, cases have been declining. That is, until now perhaps. Generally speaking, case counts rise and fall in a rhythmic pattern during the week… declining over the weekend, before rising more or less steadily though the week until Friday. Owing to this pattern, comparing any individual day to the day before is not likely to be very revealing. BUT, comparing a Friday with the previous Friday, or a Thursday with the previous Thursday might yield better results. This metric is known as the “7-day delta” (or, the 7-day change), and is a leading indicator of the more widely followed 7-day average. For what it is worth, the 7-day delta has been persistently moving lower for over a month now… again, that is, until Wednesday and Thursday of this week. Both of these days are essentially flat compared to last week. I suspect this may reflect poor early results from U.S. college openings which are seeing outbreaks at major campuses across the country. I again point out that elementary and high schools will soon re-open on a more wide-spread basis and cooler weather is approaching.

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

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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