Worried central bankers are scrambling to ease public fears in the wake of a harsh market reaction to their words and actions.
Widespread concerns that the U.S. Federal Reserve Board is ready to turn off the easy-money taps and ratchet up interest rates have driven bond yields to their highest levels in almost two years, putting the global recovery at risk if markets don't stabilize soon. The jump in yields has saddled some investors with huge losses, triggered angst in equity markets, driven up financing costs and created another headache for debt-wracked European countries trying to claw their way out of recession.
Compounding the market's worries was a move last week by the Chinese government to take the air out of a dangerous domestic credit bubble by clamping down on reckless lending. This caused a sudden credit crunch that the People's Bank of China chose not to ease right away.
Bank of England Governor Mervyn King, officials with the People's Bank of China and prominent Fed figures have since donned their fire-fighting gear to try to extinguish market flames they attributed to overreaction or misinterpretation.
"I think people have rather jumped the gun thinking this means an imminent return to normal levels of interest rates," Sir Mervyn told British MPs Tuesday in his final appearance at the parliamentary treasury committee before turning the job over to former Bank of Canada governor Mark Carney.
"The Federal Reserve has merely said that the easing, in which it is still engaging, may taper at some point depending on economic conditions," he said.
"Until markets see in place policies to bring about that return to normal economic conditions, there is no prospect for sustainable recovery and without that prospect … markets understand that it will not be sensible to return interest rates to normal levels."
Richard Fisher, president of the Federal Reserve Bank of Dallas, was bluntly critical of market players in a Financial Times interview.
"Markets tend to test things. … I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they'll go after it."
Meanwhile, China's central bank issued a statement confirming it has intervened to alleviate the cash crunch and stabilize money-market rates.
"With the elimination of seasonal and emotional factors, interest-rate fluctuations and the tight liquidity situation will gradually ease," the bank said. It said higher borrowing costs that all but shut down the interbank market stemmed from a sharp rise in lending, high cash demand during a major holiday and changes in foreign-exchange markets.
Ling Tao, a deputy director of the central bank's Shanghai branch, earlier assured reporters that the liquidity risk in the banking system has been controlled, and promised the bank "will strengthen communications with market institutions, stabilize expectations and guide market interest rates within reasonable ranges."
The central bankers' comments may have some calming effect, "but the markets will clearly remain hanging on every word, and they will have to be very, very careful in the message that they send out," said Howard Archer, chief European and U.K. economist with IHS Global Insight in London. "I suspect the markets could be very twitchy for some time to come."
What has occurred, though, does not stem from investors concluding that "the world's coming to an end, so we have to sell bonds," said Arthur Heinmaa, managing partner of Toron AMI International Asset Management in Toronto. "There is some hedging that took place and then fed on itself to a certain extent. But they [market players] missed a lot of the underlying messages [from the Fed]. They were trying to be more transparent in what they're going to do."