There’s nothing comforting about the global economic outlook

Internationally, after significantly underperforming those in advanced and emerging economies, Chinese stocks outperformed both of them last month.

Finally, what some viewed as alarming talk of China-US “decoupling” has given way to the seemingly more comforting notion of a “de-risking” that would neither derail growth and trade nor cause much financial instability.

Balmy or bumpy ahead?

This growing talk of less economic and financial dispersion naturally fuels economic and market optimism. Indeed, the longer it persists, the more it may reduce uncertainty and lessen volatility within and across countries.

In turn, this would improve the prospects for soft landings at national and global levels, alleviate interest rate and currency pressures, and enable the next leg-up in asset prices to be led by securities with less inflated valuations.

Also, with the possibility of such a range of positive feedback loops among them, it is tempting to believe that in the second half of the year there will be a decisive lifting of the clouds of uncertainty that have been hanging menacingly over the global economy and markets.

As much as we should hope for all this to materialise, it would be wiser to plan for a bumpy road ahead. Just consider some of the factors that complicate the convergence that appears to be taking place.

Absent a greater contribution from supply-enhancing measures, the BoE still has a tough road ahead in its inflation fight. Meanwhile, as the more advanced ECB and Fed embark on the “last mile” of their anti-inflation mission, both will face trade-offs between meeting their common 2 per cent inflation target and maintaining financial and economic stability.

The central banking challenges extend beyond this. In coming months, the Bank of Japan faces the delicate task of making more than a tweak to its increasingly distortive yield curve control (YCC) policy regime.

It is very difficult for the US to de-risk from China without a considerable degree of decoupling.

Meanwhile, the cumulative impact of rate rises elsewhere is likely to hit harder a large set of maturing leveraged activities and zombie companies whose financial viability requires either financial restructurings or coercive reductions in debt.

In a world where manufacturing is under pressure and surplus savings are being depleted, fundamental support for market-wide price gains will lack the energy of the small set of stocks riding a huge secular wave (think artificial intelligence and other structure-changing innovations) or having “all-weather” characteristics (think traditional big tech).

Given China’s growth challenges are both cyclical and secular, the government’s traditional strategy of turbocharging markets through fiscal and monetary stimulus will prove less effective and more distortive, frustrating a rapid market convergence.

Finally, for the reasons set out in an earlier column, it is very difficult for the US to de-risk from China without a considerable degree of decoupling.

We should do our utmost to moderate the pull of the comforting convergence narratives. Failure to do so would not only translate into a premature relaxation of the efforts needed to overcome remaining short-term challenges.

It would also leave us in an even worse position to handle the secular and structural problems that face our generation and those of our children and grandchildren.

Financial Times