Time for the Fed to draw the curtain on ‘will they, won’t they’ pantomime, says Stewart Robertson.

Key points

  • Higher US rates are overdue
  • Rate-setters’ dilly-dallying unsettles markets
  • And threatens the Fed’s own credibility
  • Further prevarication risks serious reputational damage

Central banks in the West have eased monetary policy to an unprecedented extent in recent years as they attempt to nurse their economies back to health. Given the extent of the economic downturn that accompanied the financial crisis of 2008 the combined policy response was undoubtedly merited.

Indeed some, such as the European Central Bank and Bank of Japan, appear to have more to do. But for others, most notably the US Federal Reserve (Fed), the time has surely come to bite the bullet and take the final steps towards normalising policy.

Higher US interest rates are long overdue. At the start of the year the Fed had been signalling lift-off might come by the summer. But when a string of economic releases suggested the US recovery may have stalled in the first quarter, the central bank used that as an excuse to signal that rates would stay on hold for a while longer.

Then just as it looked as if policymakers could be set to pull the trigger in September with the US economy ticking along nicely, first the Chinese economy began to slow appreciably and then equity markets got jittery. So once again a rate rise was deferred.

Fast forward a month and, with the US equity market having enjoyed its best month in four years in September, the Fed was all of a sudden indicating that a December rate hike was back on the agenda.

While rate-setters’ constant dilly-dallying has kept central-bank watchers fully occupied, it has done little for the credibility of the central bank. For a start, there is little doubt that part of the volatility seen in financial markets in recent months has been down to the lack of clarity over the Fed’s game-plan.

Few ever imagined it would be a straightforward task to wean financial markets off such a potent monetary medicine. But with the US economy still doing relatively well, it makes sense to begin trying.

The economy, at this juncture, can weather a modest increase in interest rates. Furthermore, although higher interest rates will present a headwind for asset prices, the way in which markets have reacted in recent days to the Fed’s volte-face of October 28 suggests any sell-off should prove short-lived.

At the end of the day, the Fed is risking serious reputational damage, which won’t be straightforward to repair, if it prevaricates any longer.

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