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ECONOMICS
Bloomberg Businessweek
October 8, 2018
41
Because economies in Europe and Japan are
less buoyant, the process of monetary policy nor-
malization has been a lot slower. After a prolonged
period of aggressive asset purchases and negative
interest rates, the European Central Bank is inally
reducing its monthly bond buying and has signaled
both the likelihood of ending it this year and the ini-
tiation of rate hikes at the end of the summer next
year. At the same time, it would explicitly keep on
the table the option of reversing course should the
econom
y lose steam and inlation fall away from its
target. The Bank of Japan remains more cautious.
The Fed’s rate increases, along with concerns
about the contagion and the spillover of a possible
trade war, have contributed to a signiicant down-
turn in currencies and stocks in emerging markets.
U.S. stocks have continued to outperform those
of other countries, with particularly large recent
and cumulative diferences vs. emerging markets,
including some 20 percentage points so far this year.
This economic and policy divergence will
become increasingly challenging for the global
economic system. Here’s how the timeline is
likely to play out, through the fourth quarter and
beyond. Higher growth and interest rates in the
U.S. would fuel both capital inlows from abroad
and the repatriation of some U.S. funds held
there, thereby bolstering the dollar. That could
also aggravate trade tensions, the intensity of
which would likely depend largely on the degree
to which U.S. trading partners (particularly China)
are willing to make concessions.
This would threaten emerging countries with
renewed currency turmoil, higher borrowing
costs, and lower availability of private credit to
roll over maturing debt. The longer these condi-
tions persist, the higher the probability they would
undermine economic growth, aggravate inlation,
and expose an expanding set of inancial vulner-
abilities. Such spillovers would, in turn, increase
the probability of spillbacks creating headwinds
for the advanced economies.
Further economic and policy divergences in
the next few months would also be planting the
seeds for their own demise over the longer term.
How this gap will close matters a great deal for
both the global economy and inancial markets.
Convergence from below—a pickup in European
and Japanese growth—would lower inancial tensions
by reducing pressures on foreign exchange markets
and interest rates, easing trade tensions, and open-
ing a wider window for the gradual and orderly nor-
malization of monetary policy. This would beneit
both advanced and emerging countries, reducing
the risk of destabilizing feedback loops.
Convergence from above, with U.S. growth rates
falling closer to those of others, would be bad news.
Lower income growth in the U.S. would likely
weaken a critical global growth engine, intensify
trade tensions, and further polarize the political
landscape. Also, the likelihood of lower global
income in this scenario would ofset the relief that
emerging economies would feel from lessened
dollar and interest-rate pressures. It would also
expose them to unsettling periods of strained mar-
ket liquidity in the midst of waves of forced selling.
How should investors navigate this in both the
short and longer term? With such large dispersion
in asset prices between the U.S. and the rest of the
world, it would be understandable for investors
to position their portfolios in the fourth quarter
for the “antidivergence” trade. Yet, as tempting as
this may be, it could also be premature.
Over the next few weeks, we should expect the
continuation—indeed, intensiication—of the eco-
nomic and policy divergences that favor U.S. assets
in relative terms. It gets a lot more interesting over
the longer term: The longer divergence persists, the
higher the probability of a regime break in markets.
Should investors anticipate a pickup in the imple-
mentation of sound pro-growth measures in Europe
and Japan, they would be well-advised to evolve into
greater global diversiication, and do so in the con-
text of an overall increase in risk-taking. But if the
expectation is for policy implementation to continue
to underwhelm—the more likely outcome based on
current indications—then continued favoring of U.S.
assets would need to be accompanied by a reduction
in overall risk exposures. —
Mohamed A. El-Erian
*FORECAST; DATA: INTERNATIONAL MONETARY FUND, FEDERAL RESERVE, EUROPEAN CENTRAL BANK, BANK OF JAPAN
Growing Apart
The world’s developed economies are moving further out of sync
U.S.
Euro area Japan
2007
2018*
1/1/07
9/28/18
Annual GDP growth,
year-over-year
Central bank’s benchmark interest rate
6%
0
6%
3
0
-6
THE BOTTOM LINE The divergence between the U.S. and other
economies can’t last. If Europe and Japan can’t stimulate enough
growth, the global economy will be much more vulnerable.