IMF warns inflation fight, geopolitical events driving up financial stability risks

WASHINGTON: The International Monetary Fund warned Tuesday that global financial stability risks have increased, raising the risk of a disorderly repricing in markets, as it pointed to emerging markets and housing markets as particularly vulnerable.

The IMF said that “storm clouds” are looming over the global economy, including persistent inflation, a slowdown in China, and ongoing stresses from Russia’s invasion of Ukraine which have driven up the risk of a severe downturn to levels not seen since the onset of the COVID-19 pandemic.

In its latest Global Financial Stability Report, the IMF warned that global financial stability risks had increased since the April 2022 edition, leaving the balance of risks “significantly skewed” to the downside.

“The global environment is fragile with storm clouds on the horizon,” the report stated.

Lingering market vulnerabilities, tightening liquidity, stubborn inflation and ongoing efforts by central banks worldwide to raise rates to combat it have combined to create a volatile and risky environment, the report stated.

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“With investors aggressively pulling back from risk-taking recently as they reassess their economic and policy outlook, there is a danger of a disorderly repricing of risk,” the report stated. “In particular, volatility and a sudden tightening in financial conditions could interact with, and be amplified by, preexisting financial vulnerabilities.”

Markets have had a brutal year with the S&P 500 down 24% so far this year while global bonds entered a bear market and the dollar is around a two-decade high – causing problems for the rest of the world.

In particular, the IMF warned that any sharp downturn would be acutely felt by emerging market economies, where they are grappling with a “multitude of risks” like high borrowing costs, high inflation, and volatile commodity markets. The IMF also cautioned that credit spreads have widened substantially in the corporate sector, and higher rates could adversely impact housing markets.

In China, the property sector downturn has already deepened, and failures of property developers could spill over into the banking sector, the IMF cautioned.

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While banks in advanced economies seem to have sufficient capital and liquidity, the IMF noted that in its global bank stress test, up to 29% of emerging market banks would breach their capital requirements in a severe global recession, leading to a capital shortfall of over $200 billion. U.S. banks will report third-quarter earnings starting this week and are expected to show weaker profits.

The IMF said central banks must act “resolutely” to bring inflation under control, while clearly communicating their “unwavering commitment” to achieve their mandates. Policymakers also need to address persistent financial vulnerabilities to ensure sufficient market liquidity and minimize the risks of a severe, disorderly selloff. Financial regulators should closely monitor trading infrastructure and boost data available to traders to help keep markets running smoothly.