Uncertainty like this is probably one of the best weapons left available to the central banks, which have ceded a lot of power to the financial markets this year. When bond markets force up long-term rates around the world they are in effect privatising monetary policy.
This week provides the central banks with an opportunity to strike back. If they stabilise the dollar with co-ordinated interest rate changes - higher US rates matched by cuts in Japanese and German rates - they may succeed in calming the bond markets. Stable or falling long-term rates would put central bankers back in the driving seat.
The Fed begins its two-day meeting tomorrow. Though there are signs that rapid expansion in the economy may be cooling, they are not that widespread. Friday's US employment report is expected to bring news of strong growth in June, confirming the economy is still growing fast enough to rekindle inflation pressures.
On domestic grounds alone, the Fed could easily justify a quarter- point rise in the Fed Funds rate, from 4.25 per cent. Higher short-term rates would go some way to helping the dollar, though analysts like George Magnus at Warburg Securities or Stephen King at James Capel think a Fed Funds rate of 6 to 6.5 per cent is needed for more lasting stability.
A rate reduction by the Bundesbank, whose council meets on Thursday, seems less certain. The export-led recovery is showing signs of easing and the mark has strengthened, dampening inflationary pressures. On the other hand M3 money supply growth is still a whopping 14 per cent and the German central bank is concerned to win back market credibility.
The Bank of Japan, which reviewed the situation yesterday, may by contrast be willing to shave its official discount rate - now 1.75 per cent - because massive currency intervention failed miserably to prevent the dollar falling below 100 yen. If such levels persist they could do much to postpone the Japanese recovery until next year.
If this week passes without a peep from the central banks, the markets will hammer the dollar. Co-ordinated rate changes, backed up by the right communique noises from the Group of Seven, would certainly help in the short run. Over the weekend the US President warned the Fed against any 'unusual' action to support the dollar, by which he presumably meant increases in interest rates. It will take rather more than words, however, to promote the dollar. Central bankers know in their hearts that the time has come for action.