Unlike the fictional town of Lake Wobegon, it has not been a quiet week on Wall Street.  Virtually every financial asset is down.   This week we look at different perspectives on Federal Reserve communications occurring last Wednesday when Chairman Bernanke discussed tapering the pace of bond-buying.

No end in sight to wild markets.   Always brilliant in his assessments, Mohamed El-Erian of Pimco summed it up well:  “the proximate cause for recent turbulence is the change in how markets perceive central banks’ willingness and ability to support artificial asset prices.”  El-Erian was surprised by Wednesday’s aggressive (“hawkish”) remarks by Chairman Bernanke on the prospective tapering of unconventional purchases of securities. “Judging from Chairman Bernanke’s remarks, the Fed is confident that improving fundamentals will overcome current turbulence and validate high prices.  With others less sanguine about economic prospects, prices are now converging down to fundamentals rather than the other way around.”   He notes economists are all over the map in their diagnosis of what ails the global economy, but “all agree that western economies are yet to restore the engines needed for ‘escape velocity’

[i.e., economies that grow without unconventional support from central banks]…it appears that the West is nearing the end of the era where central banks are able to impose stability on a still-inherently-unstable set of economic and financial fundamentals.”

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Clearer, but less cuddly.  “The recent jitters show how bumpy the exit from super-loose monetary conditions might be.  But it was also the result of poor communication by America’s central bankers…Mr. Bernanke should beware of tapering too soon…tapering should be undertaken cautiously.  The pattern of the past few years has been for the Fed to scale back its bond-buying only to restart it again as the recovery disappointed.  The best way to avoid such a relapse, and the distortion of prolonged bond-buying, is to stay looser for longer…the other way to minimize the risks of prolonged bond-buying is to be as clear as possible about the circumstances in which it will end…Mr. Bernanke took pains to point out the path to tapering was “data-dependent”.  If inflation remains uncomfortably low or growth proves weak, the central bank could continue to buy bonds.  But it is also possible that in their desire to get out of the business of bond-buying, America’s central bankers are engaged in some wishful thinking about the future path of the economy.  And that could lead to more bumpiness ahead.

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Unwinding the world’s biggest economic experiment.  Gavyn Davies, a columnist for The Financial Times, begins with a history lesson of some big Fed turning points, none of which were “pretty”.  He says “Mr. Bernanke wants this time to be different…  He wants bond prices to fall slowly, leaving time for the financial system to adjust…There are two risks with the Fed’s exit plan.  The first …is that it sends a premature signal to the world economy that the central banks will tighten before the private sector recovery has achieved escape velocity.  This has happened before…The second danger, in sharp contrast, is that the Fed has left it too late to bring market exposures under control, in which case the unwinding might take bond yields and credit spreads much higher than economic fundamentals seem to justify….higher bond yields would spell danger for the financial system—and would mean rising mortgage rates at a time when the US housing market is only just starting to recover…the exit from quantitative easing was always going to be long and arduous.”

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