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By now, the whole world knows that the U.S. Federal Reserve badly bungled its efforts to clarify when and how it intends to stop doing extraordinary things to prop up the economy, sending waves of panic through global markets over what seemed to be an imminent end to easy money.

The reaction in the bond market was so severe that not even perennially hawkish Bundesbank officials objected when European Central Bank chief Mario Draghi broke with precedent last Thursday to declare that key ECB rates would remain at record low levels well into the future and could go even lower. That, coupled with the first tentative move toward similar guidance by the Bank of England under new governor Mark Carney, helped soothe jangled nerves.

Still, the market's biggest single worry remains: that the Fed will turn soon turn off the monetary taps. Indeed, analysts are now convinced tapering is just around the corner, particularly after the latest job report showed faster-than-forecast growth in U.S. payrolls. Friday's "data and price movement support the argument for a September start to tapering despite the small uptick in the unemployment rate," Gabriel Mann, a rates strategist with RBS Securities, said in a note.

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But reducing unprecedented asset purchases is not the same as tightening monetary policy, as veteran investment pro David Kotok points out.

"Here we are with all G4 central banks [the Fed, ECB, Bank of Japan and Bank of England] involved in forward guidance, a commitment to very low short-term interest rates and with an extended period lasting for the next several years," Mr. Kotok, chairman of Cumberland Advisors in Sarasota, Fla., said in a note to clients on Friday.

The major central banks "have determined in various ways that change in this policy is not likely to occur before 2015. Remember that 'tapering' continues these very low interest rates and is still a form of stimulus."

Mr. Kotok, who is also vice-chair of a series of central banking dialogues held by the Philadelphia-based Global Interdependence Centre [GIC], acknowledges that the signals from the Fed have changed – which accounts for the current angst and explains why conditions are likely to become even more volatile in coming weeks.

Before its recent communication malfunction, "we had a very clear message from the Fed, and markets acted on it. Businesses acted on it. Investors acted on it," Mr. Kotok said in an interview.

That message, delivered late last year, was that the central bank would begin gradually scaling back its stimulus program once the U.S. jobless rate fell to 6.5 per cent and as long as inflation remained below 2.5 per cent.

With the apparent Fed pledge in hand, market agents could set about forecasting for themselves when the unemployment rate would fall to the required threshold. They could look at the Fed's quarterly economic and inflation forecasts, weigh the opinions of various officials and mix in inflation expectations embedded in the market.

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A consensus developed, and markets priced it in. Essentially, market participants concluded that the Fed's monetary policy would remain stable and predictable for the next several years. But then Fed officials began sowing confusion by noting that they could make changes if the jobless rate stayed at even 7 per cent, advising that "incoming data" would be key to their decision.

"But if you don't know the incoming data, if you have a wide range of opinions about it and if it's inconsistent with your own published quarterly forecasts, what do you accomplish?" Mr. Kotok asked. His answer: You create uncertainty, which causes credit spreads to widen, raises market interest rates and creates even more confusion.

Matters didn't improve when Mr. Bernanke and his colleagues set out to correct the market's misconceptions. "The clarifications were non-clarifications. And the behaviours are not clear because the Fed is trying to say when they're going to do something. But they don't say what the something is."

That said, the leading central banks are "now publicly and profoundly committed to near-zero, short-term interest rates for at least two more years. That commitment might turn out to be longer. It won't be shorter," Mr. Kotok observes. "This development is bullish for investors. It means rising asset prices will continue and the short end of worldwide yield curves will remain anchored near zero."

He will be emceeing the GIC's annual Rocky Mountain economic summit this Friday in Jackson Hole, Wyo. Hawkish regional Fed president Charles Plosser of Philadelphia and the more centrist Jim Bullard of the St. Louis Fed ought to attract the most attention, which is not something that would likely have been said in the pre-crisis days. Today, "there's no question that it's the hot place to be," Mr. Kotok says of the central bank discussions.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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