Removal of Stimulus should be GOOD News

After the close of US markets today, the Federal Reserve raised it’s discount rate (the rate at which it lends to eligible institutions, generally commercial banks) to 75 basis points. This was the first increase in three years and is part of the already announced plan to gradually reduce the significant monetary stimulus that it has engaged in as part of the global effort to combat the recent severe credit crisis. This is important evidence of the Fed’s belief that the economic recovery underway in the US is real and sustainable (though still fragile…the rate is only .75%). Taking an even medium term view (weeks or months), investment markets should rejoice in the prospect of fundamental economic growth continuing. Instead, the perverse initial response appears to be more than modestly negative. Asian markets have declined today by more than 2% and, if the same mentality prevails, one can expect the same directional movement in Europe and the Americas as the new trading day unfolds.The immediate fear that reduced governmental stimulus (even if only a very modest reduction and only gradual) will stall the recovery seems to be trumping the notion that the withdrawal of government stimulus is precisely what must occur if the world’s economy is to stand on it own feet. Of course, it is true that the Fed and its counterparts around the world could get it wrong: the withdrawal of stimulus being too early or too much. But, they could get it wrong in the other direction, as well: too little and too late, with consequent inflation and renewed asset bubble risks…the very error of recent times probably contributing to the problem of excessive leverage that we are now suffering through.

My bet would be on the monetary authorities getting it more right than wrong. Consequently, if one has long term confidence in market performance but is tempted to time market entry based on “irrational” behavior, this will probably turn out to be a good day to be buying.

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