Global financial markets have rebounded so far this year but that could change abruptly, leading to “sharp tightening of financial conditions” that could have a host of negative effects on the global economy, the International Monetary Fund warned Wednesday.
In its latest report on the global financial stability, the IMF said near-term risks have risen on balance since last fall, although they remain moderate by historical standards.
The report described a broad range of financial market vulnerabilities in global markets.
“Vulnerabilities arise from leverage, liquidity, maturity, and currency mismatches on the balance sheets of governments, firms, households, banks, insurance companies and other financial institutions,” the IMF said.
Because these vulnerabilities tend to amplify in a shock, they may increase financial stability risks, the agency said.
On Tuesday, the IMF cut its global growth forecast for the third time in six months but said it expected a pickup toward the end of the year.
Read: China investment, markets recovery should boost global economy
There were several possible “triggers” that could lead to financial tightening including a shift to a less-dovish policy outlook for U.S. monetary policy. Other potential triggers were escalated trade tensions, a no-deal Brexit and a sharper-than-expected growth slowdown, the agency warned.
Asset valuation in some key markets do “appear to exceed the levels justified by fundamentals,” including in the U.S. investment-grade
LQD, +0.30%
, U.S. high-yield
JNK, +0.11%
and emerging market corporate bonds
EMB, +0.12%
, the report said.
The U.S. financial markets
SPX, +0.08%
DJIA, -0.12%
are displaying “late-cycle dynamics,” the IMF said.
“Corporate debt is skewed toward lower-rated issuers and leverage — often a precursor of financial downturns or financial crises — is close to cycle highs across most credit rating buckets,” the IMF said.
The IMF report also expressed concerns about the U.S. leveraged loan markets. The sector has seen rising debt levels and financial risk-taking while the creditworthiness of borrowers has deteriorated.
“A significant downturn or a sharp tightening of financial conditions could lead to a notable repricing of credit risks and strain the debt-service capacity of indebted firms,” the IMF said.
The IMF report noted that global financial markets have exhibited behaviors of late that have prompted concerns about its fragility.
Post-crisis financial reforms and technological innovations have reshaped the markets, the IMF said.
“Implications of these developments for the resilience of market liquidity are not yet well understood,” the IMF said.
“Although there is no clear evidence that market liquidity has significantly worsened during normal trading days, the increased incidence of ‘flash crashes’ — when liquidity evaporates suddenly — has prompted concerns about its fragility,” the agency said.
Since September, increase of liquidity strain are on the rise, with sovereign bond markets being more prone to liquidity strain than equity markets, the report said.
Quantitative easing by central banks has played a role in this new market environment, affecting the supply of and demand for liquidity, the IMF said.
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Source : MTV
