Risks are building up in the global financial system, and a further escalation in trade tensions could push the situation over the edge, the International Monetary Fund warned.
Investors have appeared complacent, however, according to the IMF’s latest Global Financial Stability Report, which was released on Wednesday. The report, published twice a year, contains the fund’s assessment of global financial conditions and highlights risks in the system.
Stock prices — particularly those in the U.S. — have hit record-high levels multiple times over the past year, which is an indication that investors have continued to take on risks. But the uncertainties surrounding trade could cause such sentiment to turn quickly and trigger a sudden sell-off in financial markets, the report said.
“A further escalation of trade tensions, as well as rising geopolitical risks and policy uncertainty in major economies, could lead to a sudden deterioration in risk sentiment, triggering a broad-based correction in global capital markets and a sharp tightening of global financial conditions,” the fund said in the report.
The IMF said on Tuesday that disruptions to global trade is threatening growth. It cut its global growth forecasts for 2018 and 2019 by 0.2 percentage points to 3.7 percent, and lowered projections for the increase in goods and services trade worldwide.
Heightened risks from the ongoing tensions between the U.S. and trading partners come at a time when emerging markets have come under pressure, the IMF noted. Countries such as Turkey and Argentina faced massive capital outflows amid rising interest rates in the U.S., which saw their currencies crashing against a strong greenback.
Problems in emerging markets have been largely country specific so far, the fund said
“For the moment, we see a lot of differentiation across countries, so when we compare advanced economies to emerging markets, we see that financial conditions remain easy in advanced economies and they have tightened somewhat for emerging markets,” Tobias Adrian, director of the IMF’s monetary and capital markets department, told CNBC on Wednesday. “But even across emerging markets, we see a lot of differentiation.”
“There are some countries that have been hit fairly hard in terms of capital outflows, currency depreciations and, more broadly, tighter financial conditions,” he added. “While other emerging markets actually have experienced capital inflows and they have seen not a material deterioration in terms of the conditions of spreads or broader financial conditions.”
Still, the organization said it doesn’t rule out the crisis widening to a greater number of economies.
“Robust global risk appetite has so far masked the challenges emerging markets may face should global financial conditions suddenly tighten sharply. In that eventuality, the risk of contagion to the broader emerging market universe could ensue, highlighting the importance of avoiding complacency,” the fund said in the report.
An IMF analysis found that emerging economies, excluding China, could experience outflows of $100 billion or more over a period four quarters — similar in magnitude to the global financial crisis.