One question dominates the economic outlook for 2010: when will the world's central banks, most importantly the Federal Reserve, start to raise interest rates?
The question matters for a simple reason. It's widely thought that cheap money has driven up asset prices generally around the world. The end of cheap money might, therefore, reverse the rises in commodity and equity prices.
The Fed says it won't move for some time. Minutes of its last meeting show that members agreed that the weak economy is "likely to warrant exceptionally low rates for an extended period".
But how long is an "extended period"? Around six months, think futures markets. These are pricing in a fed funds rate of 0.75 per cent by next December - it's currently 0.12 per cent - with rises beginning in the summer.
Economists believe this view is consistent with the Fed's latest economic forecasts. It sees the US economy growing by 2.5 to 3.5 per cent next year - around the 2.8 per cent annualised rate it by grew by in the third quarter (Q3) - and the unemployment rate falling to 9.3 to 9.7 per cent. If these forecasts are correct, says Rob Carnell of ING Financial Markets, "there would be little to stop the Fed from beginning to raise rates from mid-2010".
But they might not be right. They are, he says "not very plausible".
Ethan Harris of Bank of America Merrill Lynch agrees. He points out that in the last two recoveries from recession, the Fed raised rates later than markets expected, and he expects this time to be little different. He likens the economy to a man who's been in a bad car accident. He's out of danger now, but will need a long period of rehabilitation before he's back to full health. "The Fed is on hold for a very long period," he says, adding that he does not expect the funds rate to rise at all next year.
So what factors will influence the Fed's decision as to when to raise rates? They are:
Economic growth. Any sign of this falling short of the Fed's 2.5 to 3.5 per cent forecast means rises will be delayed.
Unemployment. One of the Fed's concerns is that high unemployment could depress consumer spending. Economists agree that it won't move until there is convincing evidence - not just one month's figures - that the jobless rate is falling.
Bank lending. Another of the Fed's worries is that bank credit is still scarce. The stock of bank loans to industrial and commercial companies has fallen by 16.2 per cent in the past 12 months. Some sign of a turnaround is needed before rates rise.
Inflation. What matters here is not the headline consumer price inflation rate; this will certainly rise over the winter as last winter's fall in gasoline prices drops out of the annual figures. Instead, the key measure to watch is the inflation rate for personal consumption expenditures, excluding food and energy. The Fed expects this to be within the range 1 to 1.5 per cent next year - it is currently 1.4 per cent - as "substantial slack in labour and product markets" holds it down even as the economy recovers. If this proves too optimistic, rates will rise sooner.
Inflation expectations. Another concern the Fed has is that super-low rates could lead to "an unanchoring of inflation expectations". Any sign of this happening - which would show up in a rising gap between yields on Treasuries and their inflation-proofed counterparts - would also hasten a rise.
And here's the thing. These factors are pretty much the same ones the Bank of England will be looking at in deciding when to end quantitative easing and start raising rates here. In outline, the two central banks face a similar decision.
The two also face quite similar risks, such as:
1. Could consumer spending weaken next year as the fiscal stimuli (such as the UK's VAT cut) are withdrawn, as inflation rises, as unemployment stays high and as the lagged effects of the loss of housing wealth continue to be felt?
2. With firms operating so much below capacity, and banks reluctant to lend, what hope is there for a upturn in capital spending? And if capital and consumer spending stay weak, where will the recovery come from once the mathematical effect of a reduced degree of stockbuilding disappears?
3. How many more losses will banks make as recession-hit borrowers default? To what extent will these losses - and the fear of possible losses - continue to restrain lending?
4. Will the rise in inflation next year really be only temporary? Or might it, when combined with easy money policies, lead to rising inflation expectations and hence to higher actual inflation?
5. Will investors continue to remain confident about holding government bonds, in the face of rising government debt?
If these risks apply to the UK and US, there's one that's perhaps greater for the UK. This is that whereas the return to more 'normal' policies elsewhere will come through monetary policy, in the UK it could come from a tighter fiscal policy as well after the general election. To accommodate this, the Bank of England might keep rates here low even if rates elsewhere in the world rise. The result could be that the UK will have lower rates than the US or eurozone. But if this happens, the world's carry traders could short sterling, sending the pound plummeting.
Perhaps a bigger danger than all of these, though, is simply the possibility that the ending of super-cheap money will reverse the rises we've seen in commodity, equity and corporate bond prices.
Or is this the biggest risk? If there's one lesson of the crisis, it's that the risks we can see are only a fraction of all the risks that are actually out there.
