The divergence among economies, and the asset-price dispersion that has come with it, remains one of the key global issues for policy makers and investors this year. The phenomenon isn't sufficiently appreciated, even though it has material impact on benchmark market relationships and leads to feedback loops between financial and economic influences. Yet it will continue to be important, defining not just the immediate future but also raising important questions about the kind of convergence that is likely to follow.
Global economic patterns, especially among advanced countries, tend to be dominated by correlation rather than divergence because of the depth of cross-border trade and financial linkages. This was the case during the financial crisis and its aftermath, and right up to the beginning of this year.
After a major collapse in gross domestic product and employment, the majority of advanced countries got stuck for an unusually long period in a new normal of low and insufficiently inclusive growth. This gave way in the second half of last year to a synchronized pickup when every major economy, except for the U.K., experienced an acceleration of growth, as did the vast majority of emerging countries.
By the April 2018 meetings of the International Monetary Fund and World Bank, conventional wisdom had fully embraced the notion of a synchronized pickup in global growth. Yet the underlying dynamics were becoming more divergent for two principal reasons.
First, the pickup was neither coordinated nor deeply synchronized. Instead of reflecting a set of common powerful factors, the phenomenon was the result of different drivers -- from a policy-induced growth acceleration in the U.S. to the less durably powerful effects of natural economic and financial healing processes in Europe. Meanwhile, the more systemically important emerging economies were recovering from one-off shocks, such as demonetization in India, the commodity price slump in Russia and political turmoil in Brazil.
Second, differences in underlying growth drivers were widening. In the U.S., fiscal stimulus was turbocharging the effects on consumption of rising household income. Corporate investment was also boosted by improving business sentiment. By contrast, neither Europe nor Japan seemed able to capitalize on the growth pickup.
Regional tensions, an insufficient focus on policy in many countries and uncertainty about the global trade regime were starting to dampen both business and consumer confidence in Europe. This was followed by growing concern about Italy and the adverse spillover effects of interest rate hikes in the U.S., as well as the gradual reduction in the European Central Bank's $4.5 trillion balance sheet. In Japan, the government continued to struggle to implement the decisive structural reforms needed to overcome deeply embedded growth constraints.
This economic divergence has had a significant impact on markets.
Since the start of this year, the yield on the benchmark 10- year U.S. Treasury bond has risen by 80 basis points to 3.21 percent, while the yield on the German 10-year bond has remained essentially unchanged at just over 0.4 percent. The current differential of almost 280 basis points is a huge historical outlier. Dispersion has also been the name of the game for two-year bonds, where the yield differential currently stands at over 350 basis points as the German notes persist in negative yield territory. At the same time, the dollar has strengthened by almost 5 percent, as measured by the DXY index.
Then there is the eye-popping dispersion in stocks. So far this year, the S&P index has outperformed the German DAX by 14 percentage points and the EEM index for emerging markets by even more. Again, these constitute notable historical outliers.