To judge by the rally in financial markets you would think the world economy is in good shape. The latest US employment figures for April, along with strong upward revisions for February and March, spurred the S&P index to a record high. They did confirm the world's largest economy is growing, but the pace of growth remains slow. That was reflected in a fall in hours worked, suggesting more part-time employment, and in the purchasing managers index for April, a forward indicator of economic activity in which 50 marks the line between expansion and contraction. This has slowed to 50.7.
Conflicting signals help illustrate a disconnect between stocks and the economy. HSBC reported that China's PMI slowed from 51.6 a month ago to 50.4 for April, on top of slower economic growth. The euro zone's PMI has fallen to 46.7. European budget officials now expect the euro-zone economy to shrink 0.4 per cent this year instead of 0.3.
The European Central Bank has responded by cutting its main interest rate by a quarter point to 0.5 per cent. It has also not ruled out fixing a negative deposit rate that effectively charges commercial banks for depositing money with it instead of lending it out. The US Federal Reserve has said it is prepared to tweak the US$85 billion a month QE3 asset-purchase programme, which has fuelled a flow of hot money into Asia.
The uncertain scenario calls for caution both from borrowers and investors. This is particularly so in Hong Kong, where low interest rates dictated by the US dollar peg have combined with an inflow of hot money and rising property prices to fuel a borrowing and spending binge, prompting the city's central bank chief Norman Chan Tak-lam to warn that Hong Kong's economy is at risk of overheating.
The chief executive of the Hong Kong Monetary Authority told lawmakers that soaring household debt and rampant consumer spending were warning signals, with the ratio of such debt to gross domestic product having risen to a record 61 per cent. The higher the ratio, the more vulnerable people will be if interest rates rise. Chan said that because much of the consumption was based on credit, once interest rates turned up the macro economy would be at risk.
We all wish for global recovery led by the US sooner rather than later. But it will bring rising interest rates that could lead to a hangover from a credit binge. Chan's alarm bells may be unexpected, but his timing is prudent.