Bumpy Road

After referring to last year’s report in the previous post, the latest IMF Global Financial Stability Report called “A Bumpy Road Ahead” was released yesterday. Nothing earth-shattering from the report when compared to previous and current commentary. The following statements are typical:

“Many markets still have stretched valuations and may experience bouts of volatility in the period ahead, in the context of continued monetary policy normalization in some advanced countries. Investors and policymakers should be cognizant of the risks associated with rising interest rates after years of very easy financial conditions and take active steps to reduce these risks.”

and

“Valuations of risky assets are still stretched, with some late-stage credit cycle dynamics emerging, reminiscent of the pre-crisis period. This makes markets exposed to a sharp tightening in financial conditions, which could lead to a sudden unwinding of risk premiums and a repricing of risky assets. Moreover, liquidity mismatches and the use of financial leverage to boost returns could amplify the impact of asset price moves on the financial system.”

With the US 10 year breaking 2.9% today and concerns about a flattening yield curve, the IMF puts global debt at $164 trillion or 225% of GDP (obviously a different basis from the IIF’s estimate of global debt at $237 trillion or 318% of GDP) and warns about the US projected debt increase due to its “pro-cyclical policy actions”.

In a chapter the IMF calls “The Riskiness of Credit Allocations” it presents an interesting graph, as below, using its financial conditions index which uses multiple inputs constructed using a methodology that’s wonderfully econometrically complex, as is the IMF way.

click to enlarge

The IMF warn that “a variety of indicators point to vulnerabilities from financial leverage, a deterioration in underwriting standards, and ever more pronounced reaching for yield behaviour by investors in corporate and sovereign debt markets around the world”.