Global fund managers told Bank of America's latest investment survey that a "hawkish Fed/ECB policy mistake" is almost as big a threat in the global economy this year as Donald Trump's trade wars. Loading The word "mistake" is a loaded term. Central bankers must pick between poisons. But the survey shows how much worry is creeping into investor thinking as the Fed raises rates a seventh time to 2 per cent, and the ECB prepares to signal the end of its bond market adventure. The unwinding of quantitative easing implies a loss of $US2 trillion ($2.7 trillion) in annual net stimulus by December, compared to peak QE. Nobody knows what the consequences will be as the Fed reverses the process at an accelerating pace, lifting bond sales to $US50 billion a month by early autumn. It is uncharted territory. "The problem with QE is that it works in practice, but it doesn't work in theory," said former Fed chairman Ben Bernanke. Monetarists and "creditists" disagree profoundly over the mechanism. Which of the two is right will determine whether the world muddles through or crashes into recession in 2019. The Fed tells us that shrinking the $US4.8 trillion balance sheet will be as dull as "watching paint dry". One of those who designed the scheme at the New York branch told me that this assurance borders on delusional. Mr Bernanke advised his former colleagues to leave QE well alone. He has so far been ignored.

Nor does anybody know what rising borrowing costs will do to a global system habituated to a decade of zero rates. "By historical standards, real interest rates are still low. But the neutral level of real interest rates is surely also much lower too. Monetary conditions may well be tighter than widely assumed," said Jonathan Loynes from Capital Economics. US two-year Treasury yields have doubled to 2.5 per cent since September. Mr Loynes says real market rates have been rising faster than they did during the run-up to the last five recessions. He sees a 30 per cent chance of slump by next year. Loading Replay Replay video Play video Play video The world has never been so leveraged, and therefore so sensitive to a monetary squeeze. The Institute of International Finance says world debt reached 318 per cent of GDP at the end of 2017, 48 percentage points higher than the pre-Lehman peak. Emerging market debt has jumped from 145 per cent to 210 per cent. That is where the trouble is brewing. It is a near mathematical certainty that the currency crisis in Argentina and Turkey - already nibbling at Brazil, South Africa, and Indonesia - will spread to the rest of the emerging market nexus if the Fed goes ahead with its "dot plot" guidance of five further rate rises by late 2019.

The Fed is not the world's central bank. Its legal mandate is to set policy for the specific circumstances of the US economy and right now the US risks an inflationary spasm due to the Peronist irresponsibility of the Trump administration. Tax cuts and pork-barrel spending threaten to push the US budget deficit to 5 per cent of GDP at the top of the cycle when it should be near zero. The Atlanta Fed's instant "GDPNow" tracker of economic growth in the second quarter is running at 4.6 per cent. Central banks around the world are moving in different directions. Credit:Bloomberg The unemployment rate has dropped to a half-century low of 3.8 per cent. There are more job offers than jobseekers for the first time since data began. "The US economy is overheating," said Torsten Slok from Deutsche Bank. You can certainly argue that global deflation lurks yet and that this remains the real danger for the next decade. But you can equally argue that the Fed risks repeating the errors of the mid-Sixties when it waited too long to snatch away the punchbowl, and let loose the Great Inflation.

The ECB is turning down the spigot in tandem, but largely for political reasons. The economic rationale is weak. Core inflation remains pinned to the floor at 1.1 per cent. The real M1 and M3 monetary aggregates are flashing amber. The eurozone economy has slowed to stall speed. Yet Frankfurt will probably tell us this week - or soon after - that it intends to tighten further. It will reduce bond purchases to zero by the end of the year. The economic rationale is flimsy. It is doing so under pressure from the northern "German" bloc. Bank of America says the ECB may pull forward the announcement to warn Italy's Lega-Grillini insurgents that there will be no monetary cover for their fiscal blitz. Loading The end of QE in Europe is doubly treacherous because it rips away the ECB shield for Italy. Mario Draghi's "do whatever it takes" no longer holds. There is no sovereign backstop except on political conditions that Rome will not lightly accept. Bond markets are certain to test this. The more immediate risk is that the US economy continues to decouple from the rest of the world this summer in a Trumpian fiscal blow-off, catapulting the dollar higher. The dollar index (DXY) has already risen 5 per cent since mid-April. A second powerful leg of the rally risks a worldwide dollar shock.

The Bank for International Settlements estimates that offshore dollar debt - much of it borrowed by private companies in East Asia and Latin America - has jumped five-fold to $US11 trillion since the early 2000s. There is a further $US13 trillion in "equivalent" derivatives, three-quarters with a maturity of less than one year. The nub of the matter is that a surging dollar forces global commercial banks to retrench and causes a liquidity squeeze through complex swap and hedge contracts. It is a toxic cocktail when combined with surging US interest rates as well. Some $US9 trillion of global contracts are priced off dollar Libor rates. Emerging markets are now big beasts. The "blowback" from any crisis into the US economy would ultimately compel the Fed to retreat. Powell has so far been insouciant. "We believe the Fed is essentially on 'autopilot'. Quarter-by-quarter rate hikes will continue until something 'breaks'," said Michael Darda from MKM partners. Every global cycle since 1945 has ended the same way, whether the dollar is strong or weak. Each was "murdered" by the Fed. Is this time really different? Telegraph, London

Fed chief Jerome Powell raised rates last week. Credit:Bloomberg