The big question,' a colleague remarked the other day, 'is whether there is going to be a double-dip recession.' It's a big question all right. But judging by the way financial markets have been performing over recent days, concern about a double dip is just so last week. Look at the Hong Kong stock market. Yesterday the benchmark Hang Seng Index closed at its highest level in almost three months, up 10 per cent from its May low (see the first chart). And the Hong Kong market isn't alone. In Shanghai the main index has climbed 10 per cent this month. US and European stock markets are also stronger, while risk assets like copper and the Australian dollar are climbing handsomely. The turnaround in sentiment is remarkable. Just a week ago investors were running scared. They had been spooked by US Federal Reserve boss Ben Bernanke's comment that the US economic outlook was 'unusually uncertain'. They had been unnerved by downturns in indices of leading indicators in the US, Europe and Asia. And they had taken fright at the moderation in China's growth rate during the second quarter of the year. But then all of a sudden the skies seemed to clear. Better-than-expected sales of new homes in the US together with strong second quarter profit figures from a clutch of big US companies boosted hopes for the American economy. Then an improvement in Germany's Ifo index of business confidence hinted that the worst may be past for Europe. And finally expectations that Beijing may begin to relax its recent tightening measures restored a measure of faith in China's growth prospects. Unfortunately, however, much of the good news may prove less substantial than investors believe. New home sales in the US may have risen in June thanks to distortions caused by the end of tax breaks in April, but they remain at very low levels. Meanwhile existing home sales, which make up 95 per cent of the market, are still deeply depressed. US corporate results are certainly strong. But that's largely because the corporate sector was so quick to cut costs and slash investment going into the crisis, not because there is any big recovery in demand. The signals from Europe also look suspect. The Ifo index of current conditions may have improved, but sceptics note it is now higher than the index of expected conditions, a classic sign that the business environment is about to turn down. The unpalatable truth is that US consumers and the US financial system are still deleveraging and paying down their debts, which means credit is contracting and demand is depressed. And the process is far from over. Economists believe it may well have another two or three years to run, during which US growth will be anaemic. Meanwhile in Europe, fear that further fiscal profligacy will be severely punished by the bond market is forcing governments to tighten their belts and cut spending to reduce their deficits; a slow and painful procedure that will inevitably suppress economic activity for a long time to come At the same time, hopes of a relaxation in Chinese policy settings may be wide of the mark. Last year's rapid growth in the face of a crushing export slowdown was achieved only by a massive 30 per cent increase in bank credit. Recent tightening measures have slowed that growth a touch to 22 per cent year on year in June (see the second chart). But according to John Greenwood, chief economist of investment management house Invesco and the designer of Hong Kong's currency peg, that's not nearly enough. He argues that the authorities need to bring the rate of credit growth down to 15 or 16 per cent at most and keep it there if they are to prevent over-heating and inflation. 'China's squeeze needs to continue for the balance of this year,' he warns, adding that growth is likely to undershoot its sustainable trend rate of 8 to 9 per cent during the process. As a result, with the US deleveraging, Europe tightening its fiscal belt and China trying to rein in credit growth, economic performance in the world's major economies is set to disappoint in the medium term. That doesn't mean a double dip is on the cards. With central banks in the developed economies keeping interest rates close to zero and pumping money into their financial systems, growth should remain in positive territory - just. But it does mean that the recent rally in financial markets may be a tad over-optimistic. To answer the big question: no there won't be a double dip recession. But for much of the world it will feel like there is one.