It is a time of great change in the United States as the presidency of Joe Biden finally gets into gear . With an urgent need to defeat the Covid-19 crisis and repair the US’ beleaguered economy, Biden’s administration will leave no stone unturned in its drive towards faster recovery. This may not be the best time to be thinking about the US Federal Reserve weighing up its options for future policy tightening, but the whispering campaign for higher US interest rates has already begun. The Fed has spearheaded recovery efforts as far as it can with super- soft monetary policy , but now it’s up to the US government to take the strain of economic reflation going forward. Global markets had better get used to the notion that borrowing costs will be going up in 2021, and not just in America. Where the US leads on rates, generally the rest of the world follows. It means a fresh start for the Fed after four years of relentless badgering by former US president Donald Trump to ease policy even further and slash US interest rates into negative territory. The Fed’s long-guarded independence is paramount and may mean that some early countercyclical fine-tuning is overdue. The Fed will want to normalise policy from near-zero interest rates and extended quantitative easing, which has exploded the central bank’s balance sheet assets to an eye-watering US$7.4 trillion. But the Fed also needs to finesse a soft landing especially while the outlook for US growth, employment and inflation remains unclear. It is going to leave the Fed extremely conflicted on the best way forward, but luckily with Biden’s focus on unity, policy battles with the government should be a thing of the past. Policy decisions won’t be easy with the economy on the turn, especially coming out of deep recession into rapid recovery. The Fed’s dilemma is whether Biden’s US$1.9 trillion rescue plan, worth around 9 per cent of gross domestic product, risks overheating the US at the same time that the economy is being swamped with liquidity from the Fed’s bond buy-back programme under quantitative easing. It’s no easy decision, as some argue the economy is being force-fed too much stimulus, while others contend it’s not enough and more is needed. This week’s fourth-quarter advance of US GDP numbers should see growth settling back into a much more moderate 3 to 4 per cent range after the third quarter’s spectacular 33.4 per cent expansion, but it’s too early to say whether the recovery is home and dry yet. There are still too many signs of excess slack and worries that the economy is firing below its full potential. Even though industrial output has staged a remarkable comeback since last year’s lows, capacity utilisation in the economy is only operating at 74.5 per cent, still below pre-crisis levels. The US jobless rate has recovered from an April 2020 peak of 14.8 per cent but continues to show fundamental weakness in the labour market with unemployment still flagging at 6.7 per cent. This may be a long way from the 3.5 per cent unemployment rate seen at the start of 2020 but, despite this, US wage inflation unexpectedly spiked to a seven-month high of 5.1 per cent in December. Could inflation be the Fed’s driving force for tougher policy? US inflation expectations hit 2.1 per cent last week, their highest level since October 2018 based on the 10-year Treasury break-even inflation rate, a proxy measure which indicates how the market foresees long-term price pressures building. Why a once-in-a-century pandemic and a stock market bubble spell trouble Headline consumer price inflation seems OK at 1.4 per cent, below the Fed’s 2 per cent target, but is gradually creeping higher. Bottlenecks are appearing in the global supply chain and cost-push inflation risks will re-engage as the recovery takes hold and if the dollar weakens any further. Has Powell got the stomach to argue for an early rate rise as a pre-emptive measure? Timing is critical here, and a Fed rate hike before the Covid-19 crisis is resolved would be a step too far politically. But might the market’s dreaded “taper” be the Fed’s preferred alternative, initially scaling back its current US$120 billion monthly bond buy-back commitment before laying the groundwork for quantitative “tightening” further down the line? The effects would be the same, with the US curve responding with rising interest rates and bond yields. With the US recovery under way and inflation edging higher, the US is living on borrowed time with near-zero interest rates. David Brown is chief executive of New View Economics