Central bankers' market influence wanes
For months, markets have been dancing to the central bankers' tune, but that may now be changing.
It must have been fun to be a central banker in the early part of 2013: You say "jump" and Mr Market says "how high?" But that seems to have ended rather abruptly.
Tokyo's Nikkei tumbled more than 7pc last week, European shares suffered their worst day in about 10 months and even the perpetual paper wealth machine known as Wall Street fell, with the S&P 500 down by as much as 1pc before levelling off.
The re-introduction of this kind of two-way risk, both for markets and for policymakers, highlights some of the difficulties of the heavy reliance on asset-pricing markets as a policy tool.
"The tremors we have seen in stocks and currency markets yesterday and today are a sharp reminder that while the Fed can fine-tune its exit from QE, moving gradually and adapting to economic developments, it cannot control the markets' reaction, which is likely to be a lot more sudden and disruptive," said Marco Annunziata, chief economist at GE in San Francisco.
"Market reactions are a lot harder to manage than inflation expectations – no matter how careful the Fed is, the exit will not be smooth."
It all makes quite a contrast from the earlier part of the year. Central bankers worldwide appear to have enjoyed rare power and respect in financial markets, in some cases a function of new policies, as with the Bank of Japan. But in others, like the Fed's, they have been pursuing the same policy all along.
The Bank of Japan, with strong support from the new administration of Prime Minister Shinzo Abe, has successfully inflated Tokyo share markets, while at the same time deflating the yen.
The Fed, which has explicitly followed a policy of inflating assets to generate economic growth, has enjoyed the support of the metronome-like equity market, which has risen 13pc so far this year with little volatility.
Even the European Central Bank, which faces serious structural issues in the single currency zone, has seen a satisfying fall in effective sovereign interest rates, in part because markets themselves have given full credit to Mario Draghi's "whatever it takes" pledge to defend the project.
So was last Thursday simply a bad day for markets, or does it presage more difficult conditions for policy makers, the economy and investors?
Japan's situation is particularly complex. While the BOJ and central bank head Haruhiko Kuroda paid lip service to concerns about spiking interest rates, of note was that actual bond buying didn't stop 10-year JGB rates from hitting 1pc for the first time in two years.
The BOJ launched a 2 trillion yen fund supply operation, as well as two bond-buying efforts totalling 810 billion yen.
The worry is that spiking yields will draw more speculative bets, as well as potentially imperiling bank lending and capital adequacy.
As for the Fed, there really wasn't much in Ben Bernanke's congressional testimony or in the release of the Federal Reserve minutes that should have changed minds in the market, but nonetheless it did.
While Bernanke did say in answer to a question that if the data merits, the Fed "could take a step down in the next two meetings", he also balanced that, as he has in the past, by noting that premature tightening could slow or end the recovery. He further gave no indication that he regards the recovery as self-sustaining, thus making the promise, or threat, of an early taper somewhat empty.
Of the two issues, in Japan and the United States, the threat of rates in Japan is far more serious.
Theoretically, Bernanke can and will keep the bond purchases coming, thus neutralising and reversing a destabilising market tumble. It is the fact that markets in Japan were tumbling because its bond market wasn't reacting as wanted to BOJ purchases that is scary.
In the case of the Fed we can debate whether or not its policy is having the needed economic impact without losing faith in its ability to influence asset prices. In Japan, with its heavy debts, the fear is that authorities are losing control in a more profound way.
What is true in Japan has meaning everywhere, which is perhaps the best explanation for the global sell-off. \ (Reuters)