The
International Monetary Fund is cautioning against overexuberance in markets as
investors look for central bankers to pull off a “soft landing” in their
years-long inflation battle.
In
its latest semi-annual Global Financial Stability Report, the IMF noted that
markets have turned “quite optimistic” since the October edition, when
investors were still recovering from spring turmoil in the banking sector.
Now,
downside risks are receding, but the IMF is cautioning against complacency,
noting that stretched valuations across a range of asset classes, geopolitical
tensions, and rising debt levels could all pose problems if central bankers
have to keep rates higher for longer to contain stubborn inflation.
“Confidence
in a soft landing for the global economy is growing,” the IMF wrote in its
report. “However, global inflation remaining persistently above those targets
could challenge this narrative and may trigger instability.”
Specifically,
the IMF said central bankers and other policymakers need to move cautiously as
inflation eases, and push back against “overly optimistic expectations of the
pace of disinflation and monetary policy easing.”
The
report comes days after stronger than expected inflation numbers trimmed hopes
the Federal Reserve could start cutting rates soon.
“The
primary risk there is the extent to which central banks, particularly in the
U.S. … may in fact not end up delivering the cuts,” said Fabio Natalucci,
deputy director of the IMF’s Monetary and Capital Markets Department.
While
risks loom, the IMF did find that the overall banking sector has stabilized
somewhat since the 2023 turmoil. It still cautioned that there is a “tail of
weak banks” globally that merit a close watch.
All
told, banks holding about 19% of global banking assets have breached at least
three of five key risk metrics the IMF tracks as a gauge of bank health, with
most of those firms found in the U.S. or China.
Furthermore,
the report noted there are over 100 banks, which represent about 3% of the
assets in the banking system, that are struggling under a “triple-whammy” of
strains. Those firms have high concentration in commercial real estate, large
unrealized losses relative to their capital reserves, and over 25% of their
deposits are uninsured.
Natalucci
said the overall banking system appears well placed to weather anticipated
stress in the commercial real estate sector, where borrowers are still struggling
amid large office vacancies and other post-pandemic factors. However, specific
firms with particularly high exposure could face pressure, as the decline in
commercial real estate prices is the steepest in decades and has been partly
offset by a relatively strong economy so far.
The
April GFSR also marked the first time the IMF focused on cyberattacks as a
financial stability risk, noting that the risk of “extreme losses” has
increased, as financial firms have seen their losses climb from the millions to
the billions in recent years.
While
no cyber incident has proven a threat to the overall system yet, the IMF warned
the frequency of attacks is rising significantly, with the number of attacks
nearly doubling since before the COVID-19 pandemic.
The
IMF called on financial firms and regulators to strengthen their systems and
policies, particularly in emerging markets lagging behind more established
economies.
The
IMF also called on policymakers to boost their visibility into the private
credit sector, wherein firms outside the traditional banking sector and markets
provide lending. The group warned that that sector has grown rapidly in recent
years, but has yet to withstand an economic downturn at its current scale. It
called on global supervisors to adopt a “more intrusive” approach to the
sector, and boost data collection to better identifying looming risks.
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