Macroscope | The Fed is returning to the real world of higher interest rates

It is fair to say the world economy is stuck in a very troubled state right now. Burdened by crippling financial debt, bloated by central bank super-stimulus and plagued by deepening political risks, the global economic picture looks increasingly uncertain. Global stability is living on borrowed time and in need of more than just temporary fixes.

There is little chance of world leaders riding to the rescue. After last week’s lacklustre Group of Seven summit, gone is the chance of all hands to the pumps to revive global growth. World economic fortunes are now in the hands of the US Federal Reserve, central bank to the world’s largest economy, and judging by hints from chief Janet Yellen, global markets could be in for a rocky ride in the next few months.

Yellen is definitely clearing the decks for another US rate rise after warning last week that the Fed should tighten again in the coming months, if the US economy continues to pick up momentum and jobs keep being generated. The markets should get another good insight to the Fed’s near term intentions this Friday when May’s US employment report is published.

US employment data is one of the best gauges for Fed policy leanings and the numbers should be pointing to another interest rate rise without much further ado. Market surveys are anticipating another strong set of figures with the non-farm payrolls headcount expected to add a further 170,000 jobs in May, slightly more than April’s 160,000 rise.

US labour markets have come a long way in the last seven years with the unemployment rate cut in half to 5 per cent from the 10 per cent peak hit during the 2008-2009 recession. But now US labour markets are starting to look overcooked. The Fed has been paying plenty of lip service to weak international conditions but now is the time for domestic considerations to take priority. With global energy prices pushing steadily higher, the Fed must avoid taking too many liberties with longer term cost-push and demand-pull inflation pressures.

Clearly, Yellen’s words were aimed to put the markets on notice for an early rate rise. It has made an impression on the markets with trading in US Federal funds at the end of last week factoring in a 1-in-4 chance of an increase at the June 14-15 policy meeting and a 1-in-2 chance of a hike at the July 26-27 gathering. If the Fed can get a rate rise in early enough, there may be enough time to squeeze in a further hike before the 8th November US elections, perhaps as soon as September.