For all the talk that central banks have taken over financialmarkets, the paralysis gripping the Federal Reserve over upsettingbond traders sure makes it seem as if it's the other wayaround.

Time and again, Janet Yellen and other Fed officials have triedto jawbone investors into believing they were finally ready toraise interest rates. Yet time and again, whether it was because ofBrexit,a slowing Chinese economy, or just lackluster growth at home, theylost their nerve.

The consequences have been significant. Not only have doubtsabout the Fed's resolve left traders convinced there's little morethan a 50-50 chance rates will rise at all in 2016 (policymakers began the year predicting four hikes). They've alsofueled a sense of complacency that has everyone from JeffreyGundlach to Bill Gross warning bonds are overvalued. But perhapsmost important of all is that the perceived loss of credibility hasleft the Fed with no good choices. Either raise rates now and riskblindsiding investors, or hold off longer and reinforce the viewit's at the mercy of the markets.

“Thefact is that the Fed is beholden to what market participants saythe move is going to be,” said Colin Robertson, who oversees US$398billion as the head of fixed income at Northern Trust AssetManagement. “Someday, sometime, they just have to shock the marketand deal with the collateral damage.”

Futures traders are now pricing in just a 20 percent likelihoodthe Fed will lift rates by 0.25 percentage point at its Sept. 20-21policy meeting, down from more than 40 percent in late August. ToRobertson, it might as well be zero. RBC Capital Markets, one ofthe Fed's 23 primary dealers, said in a Sept. 14 report that a ratehike this week would be “the mother of all surprises.”

Central banks worldwide are discovering just how hard it is towean investors off their easy-money policies. This month, when theEuropean Central Bank (ECB) refrained from taking more aggressivesteps and speculation emerged the Bank of Japan was mulling ways topush up long-term bond yields, the U.S. stock market tumbled, whileU.S. Treasuries suffered the biggest losses in more than ayear.

In the U.S., there's little conviction among traders that theFed will do much to disrupt the status quo, either this month or inthe months and years to come.

One market metric suggests that five years from now, the Fed'starget rate will rise to about 1.25 percent, from a range of 0.25percent to 0.5 percent today. The measure—known as the one-yearswap, five years forward—has tumbled a full percentage point justthis year.

At the same time, the bond market's inflation expectations,a key measure the Fed uses to guide its policy decisions, haveremain subdued. The five-year outlook starting in 2021 currentlystands at 1.5 percent, less than the Fed's 2 percent target foractual inflation and well below its historical average.

That's been the case even as several Fed officials ramp up theirrhetoric. Yellen and Vice Chairman Stanley Fischer hinted in August thatthe bank may raise rates at least once this year, if not twice.Regional presidents from Boston to Cleveland toed a similarline.

Part of the skepticism has to do with the Fed's own actions. InSeptember 2015, the policy makers stunned the market by standingpat, even after a majority of traders in August bet that they wouldfinally end their near-zero rate policy. The bank eventually movedin December.

This time, the way that Yellen has avoided spelling out specifictiming betrays the Fed's lack of conviction, says Western AssetManagement's John Bellows. That suggests the central bank is reallyjust trying to keep its three remaining meetings “live” this year,rather than laying the groundwork to tighten.

“She's been much more careful, talking in very general termsabout the case for rate hikes being strengthened without any timereference, without anything concrete,” said Bellows, who helps runthe $604 million Western Asset Short-Term Bond Fund.

That's not to say everyone is counting out the Fed. LauraRosner, senior U.S. economist at BNP Paribas, says she expects aSeptember hike, while Columbia Threadneedle Investments' GeneTannuzzo says that if he had to pick between a move this month orDecember, he'd take the former.

“If you make a list of their voters and their most recentcommentary, I think an honest read says they want to go,” saidTannuzzo, a money manager at Columbia, which oversees $460billion.

Executives as Pimco, BlackRock Inc., and JPMorgan Chase &Co.'s money management firm told Bloomberg Television on Sept.16 the Fed will probably raise interest rates in December.

And if the Fed does move, many investors will have no one toblame but themselves. Despite repeated warnings from luminarieslike Gundlach and Gross that the 30-year bull market in bonds mayhave finally gone too far, yields on benchmark Treasuries are stillless than 0.4 percentage point from their all-time low in July.They yielded 1.69 percent today.

Globally, yields on more than $11 trillion worth of bonds arestill below zero, meaning that buyers are effectively betting thatthey can profit from further price gains.

Whatever the case, the disconnect between the Fed and themarkets seems destined to leave more losers than winners in itswake.

Raising rates now risks a backlash that could cause borrowingcosts to surge and stymie the central bank's push to support jobgrowth and inflation. It would also open up the Fed to aflurry of criticism, whether it's a lack of transparency or faultycommunication. Doing nothing costs policy makers their clout andleaves them at the mercy of future data (not to mention the U.S.presidential election and the vagaries of ECB and BOJ policy).

That's risky, particularly when Boston Fed President EricRosengren says that failing to raise now could shorten, rather than lengthen, thecurrent expansion.

“They're concerned that any misstep, or what might be perceivedto be an aggressive policy move, could upset risk assets and unwindthe economic progress,” said Michael Fredericks, the head of incomeinvesting at BlackRock Inc., the world's largest money manager.

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