Tuesday, April 3, 2012

No more QE is good news

Today's Fed news—at their last meeting the FOMC saw no need for further stimulus unless the economy were to deteriorate—seems to have disappointed the market: bond yields jumped, the dollar jumped, and equities sunk. One can infer from these moves that the market was counting on another round of QE to boost the economy. I think the market's initial reaction to this news is mistaken, because, as I have argued in many recent posts, the economy is improving on its own and more monetary stimulus was not only unnecessary, but would have been harmful. Monetary stimulus can facilitate a recovery if the problem is a lack of liquidity, but that is not the case today. Monetary policy cannot create growth out of thin air (via the printing press) if their is no shortage of liquidity in the system. The Fed's decision to finally ease off on the monetary accelerator is welcome and probably a bit overdue. The gold market is right to be disappointed, and a stronger dollar makes sense—because monetary policy is turning out to be somewhat tighter than the market had expected—but this is not a reason for the economy to weaken or for equities to fall.

Consequently, I view the selloff in equities as a buying opportunity.

This chart is a reminder that bond yields have been very low despite the fact that the economy has been slowly improving and the equity market has been rallying for the past six months. The bond market was counting on some more Fed "stimulus" to keep bond yields low, but the equity market was reluctantly responding to improving economic data (e.g., lower unemployment claims, strong corporate profits). With the promise of QE3 now shelved until evidence of renewed weakness turns up, bond yields have lots of upside potential.

The Fed is right to put QE3 on hold, because the economy doesn't need more monetary stimulus. Doing the right thing is never bad. Indeed, I think today's news from the Fed should reassure markets that monetary policy will not spin out of control. Plus, with this news the Fed has effectively given the economy a vote of confidence, and the equity market should sooner or later realize this and strengthen.


Benjamin said...

The Japanese stock market also repeatedly reacted badly to their central bank's decision to stay with tight money in the last two decades. The yen has been very strong.

Indeed, the Japanese stock market is down 75 percent in the last 20 years, in the Bank of Japan tight-money era.

I hope the Japanese media picks up on this Scott Grannis post, so that Japanese investors know of the huge buying opportunities they have missed in the last 20 years.

Squire said...

Anecdotally, my CPA friend with auto dealership clients throughout Northern California said their sales for March were up 15%. It is hard to get a better local indicator than that.

If I were in charge I would gradually reduce the deficit and gradually let interest rates rise. Eventually health care will bankrupt the country but in the mean time…

If enough speculators (like me)got into stocks because of probable QE3, the market could drop some while they get out and reconsider.

Dr William J McKibbin said...

More or less dollar liquidity is irrelevant at this point -- the end of the dollar (Federal Reserve Note) is near -- I expect that dollars will be replaced with other currencies within a decade -- electronic currencies are not the same as Federal Reserve Notes -- the sunset of the US Federal Reserve Note is now underway...

William said...

Never pay too much attention to what market commentators say is the cause of daily or even short term fluctuations in the stock market. Everyday they must write about something - but that doesn't mean that they actually KNOW what they are talking about.

After market participants sleep on it, they will realize that the FED's comments were a vote of confidence in the economy and the equity market. The comments were also a huge cautionary note to bond investors.

When the FED finally does raise the prime rate by a quarter of a point, the market might sell off briefly but that decision will be an even more substantial vote of confidence in the economy. And savers will finally earn something albeit too little.

PD Dennison said...


How do you explain Japan's situation over the past 25 years?

Would you consider Japan's monetary policy as tight? Japanese inflation has been very low, but interest rates have also been low.

The government has been spending on "stimulus" programs. Has this been wasted money (like Obama's "stimulus" program)?

What explains the 25 years of Japanese malaise?

Scott Grannis said...

Re Japan's malaise: First, I would note that Japan's travails in recent decades have been exaggerated. Per capita real incomes have been rising and real GDP per capita has been rising, only at a slower rate than most of the western world.

Why the relatively slow growth? Monetary policy has probably been too tight, and the best evidence of the degree monetary tightness is the strength of the yen, which has risen against every currency on the planet. (The very weak dollar reflects the opposite policy stance in the U.S.)

I would lay a good deal of the blame, however, on Japanese fiscal policy. Japan's deficits and debt relative to GDP far exceed ours. The government has effectively commandeered a huge portion of the economy's resource and spent them in inefficient ways. This has sapped the growth potential of the economy; scarce resources have been squandered that could have been utilized much more effectively and efficiently by the private sector. As a subset of this problem I would point to Japan's penchant for industrial policy, which has directed massive amounts of "stimulus" to favored industries.

Fiscal "stimulus" spending has rarely proved to be effective at stimulating growth, but it is almost always effective at encouraging waste and corruption. The U.S. is now seeing the folly of all the money we have lavished on "green" industries (e.g., Solyndra, etc.).

PD Dennison said...

Makes sense...

Thanks Scott!

Steve K said...

Adding my 2 cents to Japan: Very crony capitalist society. I understand the banks kept a lot of bad loans on the books over the years. Bad management stays in control of banks, businesses, etc.. So you have what the USA has experienced, imcompetent managers that should have been sacked 3 or 4 years ago, running companies that are surviving on helicopter Ben's free money.