From IMF to World Bank, the financial warnings piling up should jolt us out of our complacency

The belief that markets will recover as soon as inflation is curbed and interest rates have peaked is sheer ignorance
Experts warn that a systemic crisis is looming, affecting everything from banks and insurers to the housing and cryptocurrency markets

Anthony Rowley

Published: 2:30pm, 16 Oct 2022

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JPMorgan Chase CEO Jamie Dimon put the wind up markets with his recent warning that stocks could fall a further 20 per cent as recession threatens the US economy. Yet that is nothing compared to the wider threat of a systemic financial crisis or crises that has since come to light.

As was revealed during the unusually sombre annual meetings of the International Monetary Fund and World Bank last week, risks go well beyond simply a further drop in equity, bond and other asset prices. They extend to banking systems, all manner of other financial institutions, housing markets and more.

The implication is that markets and the global economy may need to brace themselves not just for a hard but a crash landing, and that the already stretched “emergency services” – government budgets and central bank resources – will need to be on hand again to attempt a rescue operation.

This is not the conventional market “wisdom”, which holds that once the US Federal Reserve and other central banks signal that inflation is under control and interest rates have peaked, stocks will return to an upwards trajectory, even if they do suffer a “Dimon dive” first.

This is a dangerous complacency born of the fact that many observers seem ignorant of how economies and markets act and interact, especially in a crisis, as the IMF’s semi-annual Global Financial Stability Report released just a few days ago has joltingly reminded us.

Financial vulnerabilities, it said, “are elevated for governments, many with mounting debt, as well as nonbank financial institutions such as insurers, pension funds, hedge funds and mutual funds. Rising rates have added to stress for entities with stretched balance sheets”.

IMF managing director Kristalina Georgieva speaks at Georgetown University in Washington, US, on October 6. She said the global economy was at increasing risk of recession and could lose US$4 trillion in output through 2026, a “massive setback” roughly equivalent to the size of Germany’s economy. Photo: Bloomberg

That’s about as close as you can get (if you are not to be charged with actually precipitating disaster) to saying that we are headed for a global systemic financial crisis, one which could dwarf even the 2008 global financial crisis in size and fallout.

It’s hardly necessary to explain this. The prospective crisis is looming when the global economy is still struggling to recover from Covid-19, geopolitical tensions are elevated, economic linkages are fractured and climate change is beginning to wreak economic havoc.

I make no apology for returning to the subject of financial system risk just one week after highlighting an earlier IMF warning that trouble could be brewing in the US$41 trillion “open-end” (mutual) fund sector. This has been no ordinary week and has been punctuated daily with further warnings.

05:31

Hong Kong Monetary Authority chief Eddie Yue on future of city’s economy amid higher interest rates

The tightening monetary policy and diminishing financial liquidity that is jeopardising the ability of funds to redeem investments in the key mutual fund sector is something markets should take much greater note of. To mix metaphors, liquidity is the oxygen of the financial system.

As the IMF notes, there is a risk that “rapid, disorderly repricing of risk in coming months could interact with, and be amplified by, pre-existing vulnerabilities and poor market liquidity. Market liquidity metrics have worsened across asset classes, including in markets that are generally highly liquid”, including in US bonds.

Where will this drying out strike next? IMF’s head of monetary and capital markets department, Tobias Adrian, raised a number of (chillingly) possible answers in a blog timed to coincide with last week’s annual meetings of the Bretton Woods institutions.

Fed’s inflation fight could push US economy to breaking point

Banks, he observed, have been bolstered by high levels of capital and liquidity buffers after getting badly burnt in previous financial crises, and are assumed to be safe. But debt distress is building rapidly and there will be no early reprieve from rising interest rates, as officials emphasised in Washington.

So-called “non-banks”, including insurance companies – which nowadays rival banks as sources of consumer credit – are especially at risk. As the IMF warned, those who deal with non-banks need to be vigilant about the relative lack of transparency and high leverage in this rather shadowy sector.

The global corporate sector is meanwhile being pressured in the economic environment. Credit spreads have widened substantially across all sectors and large firms report a contraction in profits owing to higher costs while at small firms, bankruptcies have started to increase.

The property sector too is getting hurt. The “faltering property sector in many countries raises concerns about risks that could broaden and spill over into banks and the macroeconomy,” said the IMF. “Risks to housing markets are growing because of rising mortgage rates and tighter lending standards.”

As central banks aggressively tighten monetary policy, soaring borrowing costs and tighter lending standards, coupled with stretched valuations after years of rising prices, could adversely affect housing markets. “In a worst-case scenario, real house price declines could be significant,” said the IMF.

Meanwhile, cryptocurrency markets have also experienced extreme volatility, leading to the collapse of some of the riskiest segments and the unwinding of some cryptocurrency funds. As central banks dig in on battling inflation, most of these flagged risks can only rise – a sobering thought for market optimists.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs