The implications of higher US interest rates have been the focus of much speculation and concern. Economists and the financial press spend endless hours trying to decipher Fed-speak for nervous investors. In this tightening cycle however, the Federal Reserve has been anything but subtle. Last November, Chairman Alan Greenspan gave an uncharacteristically blunt assessment of bond yields at the time, warning that investors who were not "appropriately" hedged against rising interest rates were "obviously desirous of losing money".

In the post-bubble economy however, things do not seem to work as they normally should. Longer dated bond yields have not risen, even as the Federal Reserve's concerns about inflation have become more vocal. When it started tightening monetary policy on June 29, 2004, the yield on the ten-year Treasury was 4.61 percent. Tightening cycles tend to last around a year, but if one uses the long run average of real interest rates or interest rates adjusted for inflation, it would mean that interest rates need to climb in the region of 3.5 to four percent before monetary policy could even be qualified as "neutral". Yet, although interest rates have already risen a total of 200 basis points, the yield on the ten-year Treasury bond is currently hovering around 4.25 percent.

The Federal Reserve actually has very little control over longer term interest rates, but it's complete impotence in this tightening cycle is surprising. It must raise some concerns for them. Cheap long-term money helps explain the housing bubble, I mean "boom". For his part, Mr. Greenspan has conceded that the bond market's behaviour presents something of "a conundrum" that needed to be studied further. Policy makers however may have to shift their attention towards bigger conundrum. The question of growth versus inflation will pose a significant challenge for the Federal Reserve, especially since a mild form of stagflation ? low growth/rising inflation ? may already be upon us.

The inherent discounting mechanisms in the financial markets are already indicating that the Federal Reserve's rosy growth expectations may be too optimistic. The bond market is strongly suggesting this and recent data certainly seems to support it. There is little doubt that the US economy slowed in the first quarter. The more pressing question is whether this is a temporary lull. It is still unclear whether this is indeed the case.

Friday's stronger than expected employment numbers however suggest that the US economy may have more momentum than recent data has suggested. It certainly keeps the Federal Reserve in play in terms of tighter monetary policy. Taken in the global context as a whole however, the outlook is less certain.

Growth in the global economy looks to have peaked, at least according to the economists at the World Bank.It is therefore difficult to get too worried about inflation at this stage in the cycle. This pre-occupation with rising commodity prices, which seem to be in a bubble of their own, certainly seems unwarranted because wages actually make up the biggest component of final prices. While cyclical inflationary pressures may be building, labour costs have remained relatively low, especially compared with other economic expansions. Commodity prices have also come off the boil recently, with copper prices hitting a three-month low last week. While the base metal is a good indicator of future demand, inflation is not. In controlling inflation therefore, the Federal Reserve has a difficult job.

Merrill Lynch's economist David Rosenberg has been warning that interest rate policy is an even more unreliable economic indicator because the Federal Reserve typically overshoots. The history of recent tightening cycles bears this out. It shows that once the Federal Reserve has started raising interest rates, they are typically slow to adjust to changes in the macro-economic environment. Mr. Rosenberg points out that the Federal Reserve in the Greenspan era has actually been one of the slowest in terms of adjusting monetary policy to changes on the economic landscape.

In late 1994, during the Mexican Peso crisis, which mobilised the Clinton Administration to orchestrate a $52 billion bailout package to thwart an economic meltdown of the entire region, the Fed maintained its tightening bias. It raised interest rates in February of 1995, before easing in the summer of that year.

Similarly, during the Asian crisis in 1997, the Fed maintained a largely tightening bias. It had eased before Russia's default on it debt, but was only pushed into action after this precipitated the collapse of Long Term Capital, which threatened to undermine the entire global financial system because of the extent of it losses.

When the equity bubble finally burst in March, 2000, the Federal Reserve continued to raise interest rates a total of 75 basis points to six percent. It maintained a tightening bias even though the equity markets were in a virtual free-fall. By the end of 2000, the Nasdaq had lost more than 52 percent of its value. The broader S&P was down more than 19 percent, but the Federal Reserve did not begin to cut interest rates until January, 2001. It slashed interest rates a total of 475 basis points following that, but the economy was already sunk by then.