Global markets have taken heart from a truce in the trade war and signs of yet more monetary-policy stimulus. Easy money may well give a short-term lift to asset prices, but longer-term prospects look more challenging, especially for Europe.
We see two snags with the latest market narrative.
First, the truce in the trade war is uneasy at best. If, as we believe, the trade war is just the beginning of a broader, multiyear conflict between the US and China, it probably won’t be long before things again take a turn for the worse. Plus, there’s the possibility that the trade war could spread to other countries—tariffs on European cars, anyone?
Second, even though central banks are ready to provide more stimulus, we’re worried that policy effectiveness is starting to weaken. Surely, the answer to what ails the global economy cannot be even lower interest rates and more quantitative easing? And even if more stimulus does help stabilize growth, it’s likely to do so by encouraging individuals and companies to take on even more debt, driving interest-rate sensitivity higher and the equilibrium interest rate even lower. The Bank for International Settlements (BIS) has, rightly in our view, called this a debt trap.
Faltering global growth presents a particular challenge for Europe. That’s not just because the euro-area countries are more reliant on international trade than the US and China, but also because they have far less policy flexibility. These twin vulnerabilities are highlighted in the display below: if downside risks to the global economy really do start to crystallize, the last place you would want to be is in the top left-hand corner, with a high sensitivity to international trade and low policy flexibility.