The International Monetary Fund (IMF) released its semi-annual Global Financial Stability Report on April 16, 2024. The report provided a comprehensive assessment of the global financial system and markets, highlighting potential risks in the rapidly growing private credit sector and emphasising the need for regulatory oversight.
The report also underscores the increasing risk of severe losses from cyber incidents, particularly in the financial sector, calling for enhanced cybersecurity strategies, improved data reporting, and measures to address liquidity and conduct risks. This report serves as a crucial guide for policymakers, market participants, and the public in navigating the complexities of the global financial landscape and has warned against complacency against confidence in a “soft landing” for the Global Economy, based off sticky global inflation statistics and unrealistic expectations for monetary policy easing.
Assessing inflation, the anticipation of global disinflation nearing its end and an easing monetary policy have spurred positive sentiment. This has led to a decrease in worldwide interest rates, a 20% surge in global stocks, and a significant reduction in corporate and sovereign borrowing spreads. Looking at UK inflation for example:
Figure A
Source: William John Analytics, Office for National Statistics
Inflation has substantially declined from 8.8% in January 2023 to 3.8% in March, just 1.5% over a healthy nominal target inflation rate of 2.2%. This favourable environment on a global scale has stimulated capital inflows for emerging markets and enabled some frontier economies to issue sovereign bonds after a long pause. Confidence in a soft landing for the global economy has therefore been growing, backed by better-than-expected economic data worldwide.
In addition to this, despite high interest rates, the financial system has shown resilience. Bank failures in Switzerland and the US in March 2023 did not spread to other parts of the system and therefore near-term financial stability risks have receded, reducing the downside risk to global growth in the coming year.
However, the threat of instability looms if global inflation remains above central banks’ targets, especially given the recent fluctuations in core inflation rates in certain countries.
Assessing near-term risks, the IMF points out that Global Commercial Real Estate (CRE) prices have taken a 12% hit over the past year, with the US and European office sectors bearing the brunt of the decline. This downturn, triggered by rising interest rates and post-COVID-19 structural changes, has put banks with large CRE loan portfolios in certain countries under strain.
Meanwhile, residential property prices have been on a downward trend but still hover above pre-pandemic levels. Advanced economies have seen a sharper decline due to higher mortgage rates. However, the global household debt sustainability ratios remain at modest levels, indicating that a surge in residential mortgage defaults is a distant risk.
Interestingly, volatility across most asset classes has dipped to multiyear lows, reflecting increased optimism about the end of the global rate hike cycle. But this calm masks an increased sensitivity of financial conditions to economic data releases, particularly inflation figures. Hence, any significant inflation surprises could trigger a rapid change in investor sentiment, leading to simultaneous price reversals in correlated markets and a sharp tightening of financial conditions.
Finally, the report addresses some of the more “medium-term” vulnerabilities. Corporate credit spreads have seen a reduction since the October 2023 Global Financial Stability Report, despite a slowing momentum in the recent rise of corporate earnings globally. Cash liquidity buffers for firms, both in advanced economies and emerging markets, have further diminished over 2023 due to persistently high global interest rates. By the third quarter of 2023, about a third of small firms in advanced economies and over half in emerging markets had a cash-to-interest-expense ratio below 1. This indicates potential financial stress as significant amounts of corporate debt are due to mature in the coming year at interest rates much higher than existing coupons, posing a challenge for refinancing.
On the contrary, despite an increase in defaults, corporate borrowing is recovering at a faster pace in this rate hike cycle compared to previous ones. This trend is being fuelled by the rapidly growing private credit market, which provides loans to midsize firms outside the commercial bank sector and public debt markets.
It also remarks on a new, material threat facing the global corporate stage: cyber incidents. The rapid digitalization, evolving technologies, and escalating geopolitical tensions have made cyberattacks, particularly those with malicious intent, a rising concern for macrofinancial stability.
While the majority of cyberattacks have resulted in modest losses so far, the risk of extreme losses is escalating. The financial sector, with its exposure to sensitive data, high concentration, and technological and financial interconnectedness, finds itself in the crosshairs of this cyber threat. Despite the non-systemic nature of cyber incidents to date, they pose a significant threat to the financial system. Improved cyber legislation and governance arrangements at firms could be the key to mitigating these risks. However, the inadequacy of cyber policy frameworks, especially in emerging market and developing economies, remains a challenge. It is clear that moving forwards, the need for robust cyber security measures has never been more critical.
Any opinions expressed in this document are those of William John and are provided for information only. E&OE
