AMONG central banks, one stands apart: the US Federal Reserve sits in splendid isolation as others take action, but is coming under pressure from both critical government bond traders and a rising currency.

In recent weeks central banks around the world have been cutting borrowing rates, abolishing currency pegs, as in Switzerland, and in the case of the European Central Bank, announcing massive bond-buying. Such actions are designed to pump up economic activity, and a successful reflation of the global economy would provide a hefty tailwind for US officials keen on ending six years of near-zero interest rates.

While the Fed on Wednesday revealed little new information about when it plans to raise rates and counselled a patient policy approach, the combination of global economic weakness and a rising dollar has sparked a reduction in the odds of tighter policy arriving this year, according to the bond market.

Although a number of economists expect a rate rise between June and September, and the Fed’s Open Market Committee forecasts overnight rates will be above 1pc by the end of the year, interest rate futures suggest an even-handed chance that just one increase to 0.50pc beckons. The stand-off between the Fed and the bond market reflects uncertainty over the outlook for the US economy and monetary policy. Caught in the backdraught of recent lacklustre economic data, falling inflation and concerns over global trends, US equities and junk-rated bonds have retreated this month, while the dollar has continued rising and government bond yields fallen sharply.

Retreating equities and rising dollar look increasingly at odds with desire to normalise

interest rates

The message being sent by financial markets thus increasingly appears at odds with the optimistic outlook on the economy and the desire for normalising interest rates at the US central bank.

Zach Pandl, senior portfolio manager at Columbia Management, says the US ‘is not an oasis of prosperity’ and he believes ‘either the global economy recovers or the Fed abandons its plans to raise rates this year’.

On last Wednesday the FOMC continued to forge a separate path among central banks. Its statement cited strong job gains and noted ‘economic activity has been expanding at a solid pace’, while also acknowledging ‘inflation has declined further below the committee’s longer-run objective, largely reflecting declines in energy prices’.

“The Fed is watching and waiting, their use of the term ‘patience’ is what investors should focus on,” says Steven Ricchiuto, chief economist at Mizuho Securities. Chris Rupkey, chief financial economist at MUFG Union Bank, says while the Fed has ruled out a rate rise in the near term by stressing a patient approach, ‘a lift-off in the middle of 2015 . . . is still on the table’. He adds that the Fed is ‘waiting for the downside risks to the global economy to go away, where every central bank seems to be cutting rates at the moment’.

One new aspect of the latest FOMC statement was an acknowledgment any future change in policy would reflect in part ‘international developments’.

Anthony Karydakis, chief economic strategist at Miller Tabak & Co, says: “This should be viewed as adding a subtle element of caution to the FOMC’s overall assessment of the broader picture in regards to the timing of a rate hike, as international developments are more likely to represent a headwind rather than a tailwind to US growth.”

The steady decline in Treasury yields this month reflects how, in the wake of the FOMC’s December policy meeting, wage gains have dipped and inflation has fallen further below the central bank’s target of 2pc, while retail sales have not responded positively to cheaper petrol prices.

Another key element has been the ongoing appreciation of the US dollar. A collection of blue-chip US companies has weighed down the equity market this week after revealing how the strong dollar and weaker global growth has hampered fourth-quarter earnings.

Markets will now focus on the January employment report due next week and on Janet Yellen, Fed chairwoman, who testifies before Congress next month.

“Yellen’s testimony next month will set the tone for markets,” says Mr Pandl.

Published in Dawn, Economic & Business, February 2nd, 2015

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