Flip-flopping Federal Reserve (Fed) policy defined the third quarter. Last quarter, the Fed threw the markets a curve ball by announcing possible tapering of its large-scale asset purchases beginning this year. That ?taper talk? set off a mini-riot in global bond markets. Many emerging market (EM) countries, like Brazil, India, Indonesia and South Africa, were the biggest victims, as their bond yields rose and their currencies crashed.

The first quarter of 2013 turned out pretty much as expected: a low volatility environment with the level of bond yields and credit spreads relatively stable. At some point, we have to be happy with earning a yield on our fixed income investments. The last several years have been a major bond bull market, particularly 2012, but with yields at low levels, there is not much room left for bond price appreciation and we should be comfortable with earning our yield and carry.

The ?nal quarter of 2012 was the icing on the cake of an exceptional year for the credit sectors. Fourth quarter credit gains stemmed in part from uncommonly aggressive monetary policy responses in the third quarter. As economic growth continued to undershoot expectations, major central banks made clear that they were dissatis?ed with the status quo of tepid economic growth and high unemployment. The Federal Reserve went so far as to tie its monetary policy to the level of the unemployment rate.

In an often cynical world, standard ?nancial and macroeconomic quantitative models give people the bene?t of the doubt. Fundamental economic theory assumes the best of us, supposing that human beings are perfectly rational, know all the facts of a given situation, understand the risks, and optimize our behavior and portfolios accordingly. Reality, of course, is quite different.

Those familiar symptoms are back again to start the summer: risk aversion; falling equity prices; rising volatility; record-low German and US government bond yields; wider credit spreads; a European country getting picked on; and a stronger US dollar. We have seen this bad movie twice before, during the summers of 2010 and 2011.

Aggressive policy responses from major central banks were dominant forces in the third quarter. The European Central Bank (ECB), Federal Reserve (Fed), Bank of Japan (BoJ) and other central banks took decisive action, prompted by the escalating European sovereign debt crisis, slowing global growth, ?nancial market volatility, and the impending US "?scal cliff."

Those familiar symptoms are back again to start the summer: risk aversion; falling equity prices; rising volatility; record-low German and US government bond yields; wider credit spreads; a European country getting picked on; and a stronger US dollar. We have seen this bad movie twice before. If this is indeed another rerun, we should expect central bank and other policy responses to help limit the fallout. As we see it, hesitancy and solvency traps are the main obstacles to recovery.

Those familiar symptoms are back again to start the summer: risk aversion; falling equity prices; rising volatility; record-low German and US government bond yields; wider credit spreads; a European country getting picked on; and a stronger US dollar. We have seen this bad movie twice before, during the summers of 2010 and 2011. If this is indeed another rerun, we should expect central bank and other official policy responses to help limit the fallout. As we see it, hesitancy and solvency trapsnot a liquidity trapare the main obstacles to a lasting economic recovery.

Central banks around the world sent a rush of liquidity into the global financial system, and this coordinated effort helped stem the risk of a major European credit crunch that was brewing at the close of 2011. In our view, the liquidity provision has improved the macroeconomic outlook and buys some much needed time for sovereigns, banks and other indebted private sector agents to try to get their balance sheets in order. Risk assets have generally responded very well to easy money policies over the last two quarters, while negative real interest rates have piqued the global thirst for yield.

Once an extreme event occurs, standard models offer limited insight as to how the ensuing crisis could play out and how it should be managed, which is why policy responses can seem disjointed. The latest policy responses to the European crisis have been no exception. To understand and respond to a crisis like the one in Europe, perhaps we need to consider some new models that include the human factor. Economic historian Charles Kindleberger can offer some insight

Amid the ongoing debate, the financial markets are signaling a need for liquidity. Until Europe and the US are able to demonstrate economic growth, the financial markets are likely to remain skittish, leaving risk premiums high. In the interim, policy-makers will be in the spotlight. In our opinion, central banks should supply more liquidity on a global basis in this turbulent environment. We believe such intervention can help assuage the markets.

We are experiencing a case of dj vu with another economic soft patch and a Greek solvency crisis. We saw this movie in the spring and summer of 2010, but then we got a major policy response (a European bailout, QE2, and tax cuts) that helped lift us out of the doldrums. There is no major policy response coming in 2011. In fact, many countries are pursuing tighter macro policies by raising interest rates or cutting public spending to reduce swollen budget deficits. The European response to the sovereign debt crisis has been messy, and that has been a major contributor to the recent anxiety.

The power of easy money policy to dampen volatility is evident in the global bond markets. There has not been any systemic credit spread widening or major jump in risk aversion on the back of the significant political upheaval or natural disaster. The collective investor conclusion seems to be that the impact of the losses will not derail global growth, and Japanese reconstruction may even contribute to it later this year. Specifically, Chinese growth still looks on track for a strong year, and labor markets in the US have at last begun to show something like a normal recovery.

The level of assets on central bank balance sheets has been relatively stable since the initial burst of quantitative easing in late 2008 and early 2009. As growth slows, however, money and credit numbers could drop significantly. Central banks could still do more to spur a more complete economic recovery. Until then, bond yields should remain low. Perhaps 10-year Treasury yields below 3 percent are low enough to reverse the real demand for money and force portfolio rebalancing. Investors will need to watch the corporate sector for signs of cash hoarding and hiring as evidence of that.