What Japan Can Teach the Fed About QE Addiction

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Take note, Ben Bernanke: Japan is what happens when a market demanding constant central bank stimulus doesn't get what it wants.

The Federal Reserve chairman no doubt is paying attention as the massive surge in the Japanese equity market has whipsawed lower after investors became concerned that Abenomics might come up short in goosing the economy.

Similar to the U.S. central bank, the Bank of Japan, at the urging of Prime Minister Shinzo Abe, promised to pump liquidity into the economy at a pace even faster than the Fed.

But in recent weeks indications have been that the quantitative easing from Japan may not be as big as hoped. Consequently, there's been a huge sell-off that has taken the Nikkei into bear market territory.

(Read More: Nikkei Plunges 6.4%; Re-Enters Bear Market)

"Many would characterize it as an overreaction, but it's probably an overreaction to what central banks are doing," Zane Brown, fixed income strategist at Lord Abbett, said during a panel discussion Thursday that focused on the so-called Great Rotation of cash from bonds into stocks.

The panel, assembled by institutional equity firm Liquidnet Holdings, unanimously agreed that the move from fixed income shows signs of occurring but has not happened yet.

One key: Nervousness from equity investors about central bank policy that could lead to more safe-haven bids and a limit to equity enthusiasm.

Japan has been a case study for the extent to which markets are addicted to QE.

(Read More: Is It Game Over for Japanese Equities?)

"Now there's disappointment from the Bank of Japan not being as aggressive" as anticipated, Brown said. "You have people saying there are limits to aggressive easing in terms of monetary policy."

Investors worried that the Fed might begin easing the throttle—"tapering," in the Bernanke vernacular—on its $85 billion a month in asset purchases need look no further than Japan.

"All along we've been making this assumption that they, sometime later this year or at least early next year, will start tapering the quantitative easing," Brown said. "May I suggest this may not be in a smooth line? The Fed has to consider the opposite tact."

Brown's argument is that rising interest rates are making mortgages costlier, with 30-year rates hovering now at 4 percent. There already are indications that could cut into the critically important housing recovery.

(Read More: As Prices Rise, Banks Repossess More Homes)

Should that continue, he said, the Fed may not only postpone its tapering strategy, it actually may increase QE to $95 billion a month.

That makes next week's Fed Open Markets Committee particularly compelling, as it faces a nervous market looking for assurances.

And as it contemplates the tapering calculus, the Fed has Japan to watch, as well as the recessions across the euro zone that economists blame on a flat-footed European Central Bank.

The lesson may well be that global central banks have themselves in a bit of a box.

(Read More: For Some, Fed Can Start Tapering NOW)

Indeed, current conditions indicate "how sensitive many assets have become to the prospects for unconventional monetary policy," said Julian Jessop, chief global economist for Capital Economics.

Expressing frustration common among economists and strategists, Jessop added: "Japanese equities have been hit particularly hard as the yen has rebounded and some of the over-exuberance about 'Abenomics' has faded. Even though we remain cautious on the prospects and risks for Japan, this swing in market sentiment means that many of our views now appear to be relatively optimistic compared to the consensus."

(Read More: Why Bullish BofA Thinks Market Gains Might Be Over)

Sam Stovall, chief market strategist at S&P Capital IQ, took the bright side in a note Thursday morning: The central-bank-inspired churn is in large part a growing pain global markets will have to endure on the way to less dependence on the liquidity of money printing and more on lackluster global growth turning higher.

If it seems a rosy projection given current conditions, it also is part of a broader—perhaps overly optimistic—consensus that is hoping for a turn.

"Globally, the lack of central bank easings, for fear of stoking real estate speculation, in our view, added to equity price pressures around the world," Stovall said.

He added, "While we believe this decline has further to go in time, and maybe even magnitude, we continue to look upon it as an uncomfortable metamorphosis from a liquidity-led bull market to a fundamentally driven one that will ultimately lead to even higher highs before the year is out."

By CNBC's Jeff Cox. Follow him @JeffCoxCNBCcom on Twitter.