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.