What central banks may have the world over is a failure tocommunicate.

Officials are struggling to spell out their visions for monetarypolicy, often amid a chorus of competing views. Chairman Ben S.Bernanke is trying to manage expectations about when the U.S.Federal Reserve will slow asset purchases and raise interest rates.Bank of Japan Governor Haruhiko Kuroda's reflation-push isbackfiring by driving up bond yields. European Central BankPresident Mario Draghi is dashing investors' hopes he once kindledfor extra stimulus.

The muddied messaging already is roiling financial markets,threatening to undermine the confidence of investors, households,and consumers and so undoing efforts by central banks to strengthentheir economies. The opacity puts policy makers under pressure toimprove the communication techniques they've been using to restrainborrowing costs.

“The purpose of central-bank transparency was to give marketsclarity and reduce volatility,” said Ed Yardeni, president andchief investment strategist at Yardeni Research Inc. in New York.“Instead it's increasing volatility and been counterproductive.Clearly the back-up in bond yields and sell-off aredisconcerting.”

Bernanke will get a chance to clarify the U.S. central bank'sstance on June 19 when he holds a press conference after thepolicy-setting Federal Open Market Committee completes a two-daymeeting. Rather than focusing on when the Fed will start reducingits bond buying, Bernanke probably will stress the how and why ofsuch a step, said Michael Feroli, chief U.S. economist for JPMorganChase & Co. in New York.

Bernanke will “want to emphasize that a tapering of assetpurchases is not a tightening of policy and isn't necessarilyirreversible,” said Feroli, a former researcher with the Fed boardin Washington.

Bond prices have slumped since Bernanke told Congress's JointEconomic Committee on May 22 the Fed could scale back stimulusefforts “in the next few meetings” if the employment outlook shows“sustainable” improvement. He stressed that any decision woulddepend on what the economic data showed and that a move to reducethe pace of purchases would be delayed if recovery falters andinflation falls further.

His remarks came in response to a question from RepresentativeKevin Brady, a Texas Republican and chairman of the committee.

Bond Vigilante

The dumping of debt is reminiscent of the waves of selling thattook place in the 1980s, only back then investors were worriedabout fiscal, not monetary, policy. Yardeni coined the phrase “bondvigilante” to describe the financial institutions involved.

The yield on the 10-year Treasury note was 1.93 percent the daybefore the committee hearing and went on to trade at a 14-monthhigh of 2.29 percent last week. The yield was 2.12 percent at 11:40a.m. in London today.

The sell-off in Treasuries has triggered convulsions in capitalmarkets elsewhere, with the more than $40 trillion of bonds in theBank of America Merrill Lynch Global Broad Market Index falling anaverage of 1.1 percent since May 21 as of June 13.

“Central banks have given a sense of near total control, drivingvolatility and bond yields to historic lows and compressing riskpremia,” said Michala Marcussen, global head of economics atSociete Generale SA in London. As the “countdown” to the end of theFed's quantitative-easing program advances, “volatility and higherbond yields are making a return.” She predicts the 10-year Treasuryyield will rise to 5 percent by 2017.

'Very Worried'

Alan Blinder, Fed vice chairman from 1994 to 1996, said he's“very worried” financial markets will overreact to steps by the Fedto reduce and eventually exit from its efforts to support theeconomy.

“I'm afraid it's going to be worse than 1994,” when 10-yearyields jumped almost 2.5 percentage points as the Fed tightenedcredit, said the Princeton University professor. And capital losseswill be larger because the starting point for yields is lower, headded.

Policy makers are aware of the potential pitfalls. The Fed willneed to “think carefully about what combination of actions andcommunications” it should take to head off a market overshoot onceit begins “normalizing policy,” Federal Reserve Bank of New YorkPresident William C. Dudley said on May 21.

Bernanke may be “trying to help the market build up immunity” tofuture Fed actions with his suggestion that the central bank couldcut back on its bond buying, said Lou Crandall, chief economist atWrightson ICAP LLC in Jersey City, New Jersey. “This is a littleverbal vaccination.”

Treasury yields will “probably even reverse some of the recentupward move” if Bernanke succeeds in getting investors to buy intothe Fed's complicated message, said Roberto Perli, a partner atCornerstone Macro LP in Washington and a former researcher at thecentral bank's Division of Monetary Affairs. The Fed has a historyof making markets understand its intentions, reducing fears of asharp policy tightening in 2004 and introducing a time frame for arate increase in August 2011, he said.

That message has three parts, according to Perli. While the Fedprobably will scale back asset purchases in the next few months, itwon't do so unless it is increasingly confident in the economicoutlook. It is prepared to stop tapering, or even reverse it, ifgrowth falters. And a slowdown in quantitative easing doesn't meanthe Fed is accelerating its plan for its first interest-rateincrease since 2006.

Policy makers have held the target for their benchmark rate nearzero since December 2008. They've promised to keep it around thereas long as unemployment remains above 6.5 percent and the outlookfor inflation doesn't exceed 2.5 percent. Joblessness was 7.6percent in May, while inflation, as measured by thepersonal-consumption-expenditure price index, was 0.7 percent inApril.

Investors also have been confused by a “mixed message” from Fedpolicy makers, said Marvin Goodfriend, a professor at CarnegieMellon University's Tepper School of Business in Pittsburgh and aformer central-bank official. “They're divided, so the market isdivided and therefore you're getting more volatility.”

James Bullard, president of the Federal Reserve Bank of St.Louis, said on June 10 that the low level of inflation may warrantprolonging the “aggressive” use of bond buying to spur growth. Justfive days earlier, Dallas Fed President Richard Fisher said thecentral bank should already have begun to cut back on its purchasesof mortgage-backed securities, adding that he wasn't concernedabout deflation.

Surging Yields

In Japan, Kuroda also has faced a surge in 10-yeargovernment-bond yields to 0.815 percent on June 14, even as theBank of Japan boosted its bond-buying to defeat 15 years ofdeflation. The yen also has climbed to the highest against thedollar in two months, having touched its weakest level since 2008in May after Kuroda began easing.

Such gains conflict with Kuroda's efforts to juice borrowing andspending by lifting inflation expectations and wages. He said May22 that higher yields could be expected as the economy improved,after saying previously that the central bank aimed to lower marketinterest rates.

“Kuroda needs to be consistent with what he says,” said MasaakiKanno, a former BOJ official and now chief Japan economist atJPMorgan Chase in Tokyo. “The market expectations were for a moremarket-friendly BOJ.”

The central bank last week refrained from tackling bond-marketvolatility, and Yoshiki Shinke, chief economist at Dai-ichi LifeResearch Institute in Tokyo, says investors may have looked for toomuch from the BOJ.

“It's a typical pattern that investors and traders expect acentral bank to implement policy measures to support markets, andtheir expectations are betrayed by monetary authorities,” he said.“Investors were prompted to anticipate more easing measures, butthe central bank unveiled nothing.”

Policy makers should explain that bond yields probably will riseas inflation expectations take hold and that its purchases aredesigned to hold down real interest rates, said Goodfriend, whojust returned from attending a BOJ conference in Tokyo.

The officials may be tuning in. “The bank should make greaterefforts to promote an understanding among the public and marketparticipants of its monetary strategy and pursue more effectivecommunication strategies,” BOJ board member Sayuri Shirai said June13.

'Some Self-Correction'

At the European Central Bank (ECB), Draghi is undertaking whatDeutsche Bank AG economist Gilles Moec calls “some self-correction”in its perceived stance after remarks Draghi made on May 2triggered an increase in stimulus bets. The central bank cut itsbenchmark rate to a record low of 0.5 percent, and Draghi saidofficials had an “open mind” about reducing the so-called depositrate below zero.

Draghi then played down these measures on June 6, helping topush the euro to its highest against the dollar since February andyields on Spanish and Italian 10-year bonds to their highest sinceApril.

“Communications have been a bit hard to follow lately,” saidMoec, co-chief European economist in London and a former Bank ofFrance official. Investors need to “average out” Draghi's last twopress conferences to divine the ECB's true stance, he said.

The change in tone reflects “complete disagreement” within theECB's 23-member Governing Council, forcing Draghi to find aconsensus after actively pushing stimulus, said Marc Ostwald, astrategist at Monument Securities Ltd. in London.

Hours after Draghi said in May the ECB was technically preparedfor a negative deposit rate, Governing Council member Ewald Nowotnytold CNBC that such a move “shouldn't be seen as something that'srealistic in the foreseeable future.” Colleague Christian Noyersaid in a May 28 interview he also doubts the merits of such apolicy.

The clarifications may not be over. Laurence Boone, chiefEuropean economist at Bank of America Merrill Lynch, says ECBofficials still will want to correct market interest rates toensure they remain low.

Draghi rejects talk of splits as a “dramatization” and said thediversity shows a debate is under way with few conclusionsmade.

“You have different views in all central banks, and in a periodof such uncertainty you obviously have a variety of opinions,” hesaid on June 6. “That is actually very good.”

Investor Insight

The communications challenges represent a speed bump after aperiod in which transparency has been hailed as key for policy. Themore insight investors are given into the minds of officials, thetheory goes, the more they'll be able to interpret correctly acentral bank's plans and reinforce them in the market.

At the Fed, for example, Bernanke has begun regular pressbriefings, adopted an inflation goal, and released the expectationsof officials for the appropriate path of policy rates.

The dilemma now is that officials are in what SylvesterEijffinger, a professor of financial economics at TilburgUniversity in the Netherlands, likens to what old maps would call“terra incognita”—the Latin for “unknown land.”

In the case of the Fed, while good communications are vital forcontrolling markets, they're complicated by the officialsthemselves not knowing when to exit, disagreeing over the righttiming to do so, and political pressure to hold back.

“Those factors make it very hard for the central bank tocommunicate,” said Eijffinger, who advises the European Parliamenton monetary policy. If the Fed isn't able to “control the process”to recovery and manage inflation and interest-rate expectations,then the U.S. could “be confronted with a kind of abrupt slowdownof growth” two or three years from now.

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