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The IMF has urged regulators to sharpen their scrutiny of threats from rising bond yields, as a continuing surge in global borrowing costs triggers “heightened risk” in financial markets.
“When you see large moves that are very fast, it has more potential to trigger instability, because market participants have to reposition and there are these accelerators in the system that could kick in,” Tobias Adrian, director of the fund’s monetary and capital markets department told the Financial Times. “Hopefully, calm will prevail at some point, but there is certainly heightened risk [now].”
The remarks come amid weeks of volatility in the price of US government bonds.
Yields on 30-year US debt hit a 16-year high of more than 5 per cent last week after strong data on the jobs market raised the prospect of the Federal Reserve’s benchmark interest rates remaining high for an extended period of time.
Adrian was particularly worried about banks’ exposure, especially those hit hard by the implosion of Silicon Valley Bank earlier this year.
While the recent sell-off had not yet translated to significantly wider credit spreads, that “could of course be triggered at some point”.
“There are going to be more and more stresses on the banks,” he said.
In March, regional banks in the US faced a crisis that later spread to larger institutions — even ensnaring one of Europe’s biggest lenders, Credit Suisse.
The banks that faltered suffered specific management failures, including a lack of appropriate protection against rising interest rates. But the episode laid bare how susceptible institutions could be to sudden runs.
“Forceful supervisory action can really make a difference,” he said.
Adrian’s remarks to the FT echo warnings outlined in the IMF’s latest Global Financial Stability report, published on Tuesday at the onset of the multilateral lender’s annual meetings with the World Bank, which are taking place in Marrakech this year.
In the report, the IMF warned of “adverse feedback loops” sparked by an abrupt tightening of financial conditions that could “again test the resilience of the global financial system”.
It also stress tested nearly 900 lenders globally.
Most lenders could handle the so-called “baseline” scenario of modest global growth and easing inflation — though 55, including a group of US regional banks, would be exposed to “significant” capital losses.
However, a painful global recession and resurgent inflation that leads central banks to raise rates further would put 215 institutions, which together account for 42 per cent of global banking assets, at risk. Several systemically important institutions in China, Europe and the US would be affected, the IMF said.
Despite these vulnerabilities, Adrian urged central banks to “stay the course to get inflation back to target in a durable manner”.
He noted that monetary authorities were well equipped to handle bouts of financial instability with other tools. In March the Fed rushed to stem the fallout from the banking stress with an emergency lending facility. It still managed to raise rates by another quarter point the following week.
“It’s really only in very extreme situations, such as the 2008 crisis, where there is a strong interaction between monetary policy and financial stability,” said Adrian. “We are quite a distance from that.”
Still he said the lesson from March was that the failures of a few institutions can have significant impact more broadly and that it is better for regulators to “take care of these things pre-emptively”.
Among other concerns the IMF flagged on Tuesday was the build-up in leveraged positions, especially in US government bond markets, whereby investors buy Treasuries and sell the associated futures contract, seeking to pocket the price differential between them.
“The current positioning by leveraged investors may be tested by a sudden bout of bond market volatility, forcing them to unwind positions and sell bonds just as prices for these securities fall,” the report said.
Asked about looming issues in the commercial real estate market, Adrian described that as a “slow-moving” problem, unlikely to bite for another year or two until a wave of refinancing.
“The pessimism is already priced in, but it will be painful to watch [it unfold].”
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