With the summer now behind us the focus has shifted to the remaining outstanding issues of this year – the Federal Reserve monetary policy and the US presidential election.
The two are connected as the Fed is unlikely to raise interest rates around the time of the election in November, leaving only two options for a rate hike between now and the end of the year – either this month or in December.
With senior Fed officials recently talking up the likelihood of a policy tightening in coming months, most market assumptions are that a December rate hike is now the most likely.
However, this is largely premised on the assumption that Hillary Clinton will win the presidency. If Donald Trump were to win, however, all bets would be off.
A December rate hike is also premised on the view that a Fed led by Janet Yellen is almost perennially disposed to wait until the stars are perfectly aligned before hiking rates, a view that is quite understandable given past experience.
However, there is something a little strange about the Fed recently beginning to talk up a rate rise so far ahead of when it is actually planning to do it.
After all, domestic and international factors appear to be reasonably supportive of a move today, even if they are not quite at the “perfect” place the Fed might prefer.
The latest increase in US non-farm payrolls by 151,000 last month was a little weaker than expected but need not detract from the argument for hiking rates as early as this month, with the three-month moving average standing at 232,000 and the unemployment rate steady at 4.9 per cent.
Inflation readings are still below the Fed’s 2 per cent target but are gradually moving towards it, something that a small rate rise will do little if anything to impede.
Global conditions are also very benign right now, with oil prices steady and emerging markets much less volatile than they were at the start of the year, and with the Brexit referendum already a memory.
This all suggests that the Fed has a window to hike rates without the risk of destabilising financial markets.
From another perspective, a rate hike is actually becoming more and more pressing not only for economic reasons but for the good of the financial system.
The global bonds guru Bill Gross of Janus Capital recently wrote in the Financial Times that “central bankers are threatening the engine of the economy” by keeping interest rates too low now for too long.
Mr Gross goes on to say that it is no coincidence that productivity has slumped parallel to the advent of quantitative easing and zero-bound interest rates, or that investment has declined, saying that ultimately “capitalism cannot function at the zero bound or with a minus sign as a yield”.
Insurance companies and pension funds with long-term liabilities have assumed higher future returns and will be left vulnerable if yields fail to return to more normal levels. Other distortions are also observable in many asset markets, from equities to bonds and commercial property.
The Fed does not appear to be at this level of awareness just yet, although there have been signs from some Fed officials that a reappraisal of the appropriate level for interest rates could be on its way.
The San Francisco Fed president John Williams, for instance, wrote recently that it is time to “critically reassess prevailing policy frameworks” and warned that there are limits to what monetary policy can do and hinted that fiscal policy should take more of the strain.
Finally, another dimension to the monetary policy debate is that with or without the Fed, short-term interest rates are already on the rise.
This is largely because of technical factors related to US money market regulations that come into effect next month, which have been sufficient to see the three-month London interbank offered rate (Libor) rise to 0.83 per cent, its highest level in seven years and well above the 0.25 per cent to 0.50 per cent Fed funds rate.
Changes to the Libor rate calculation methodology might also be partially responsible, along with market expectations for a hike.
The longer they stay so elevated, however, the more they add to the case for the Fed to catch-up.
Tim Fox is the chief economist and head of research at Emirates NBD.
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