A protracted economic slump across large parts of the world economy is colliding with an ever more egregious credit bubble, one that looks increasingly like the subprime excesses of 2007. This strange contradiction will be resolved one way or the other soon enough.

Germany, Britain, and Japan were all in recession over the northern hemisphere winter. France escaped by a whisker, but is now introducing austerity cuts. The latest fall in the eurozone’s Economic Sentiment Indicator has smothered hopes of a meaningful recovery over coming months.

Fed chair Jerome Powell. The Federal Reserve, the European Central Bank, and the Bank of England are all talking as if the world economy touched bottom several months ago.Credit: Bloomberg

Investors are behaving as if the West is already in the early stages of a cyclical recovery. They are betting heavily on the impossible trinity of falling inflation, double-digit gains in corporate earnings, and a Goldilocks economy of perfect pitch. But what macroeconomic force is supposed to drive this rebound?

China is still grappling with the fallout of its enormous property slump. Cities and local authorities that once depended on land sales for 42 per cent of their income have seen this revenue halve since that bubble burst in 2021. They are in the midst of a public debt crisis that dwarfs the eurozone travails of 2010-2015 in absolute numbers, if not in character.

Beijing is trickling out just enough stimulus to prevent a chain reaction – mobilising the “national team” to lift share prices on the carpet-bombed stock markets of Shanghai and Shenzhen – but not enough to lift the mood of cosmic gloom enveloping the country, or to reverse the onset of debt-deflation.

International analysts have cut their global growth forecast from 2.8 per cent last year to around 2 per cent this year, a level that used to be deemed a world recession by the World Bank. It is certainly near stall-speed.

At the same time, credit spreads on junk debt are compressed to levels seen during the wildest phases of pre-Lehman speculation. The BBB corporate debt index has dropped to a wafer-thin spread of 120 basis points. The fever has spread to risky “B”, a grade defined by Fitch as having a “material default risk and a limited margin of safety”. So much for claims that we are now in a world of scarce capital.

“Euphoria is the name of the game,” said Barnaby Martin, credit strategist at Bank of America. “What are the classic signs of a credit bubble? When discipline goes out of the window and markets buy deteriorating credits because of a feeling of ‘value’.”