The pace of global economic activity remains weak, and financial markets expect rates to stay lower for longer than anticipated in early 2019, according to the Global Financial Stability Report (GFSR) released by the International Monetary Fund (IMF).
The reported noted that "financial conditions have eased even more, helping contain downside risks and support the global economy in the near term, but, loose financial conditions come at a cost, as they leave a significant room for investors to seek higher returns, so risks to financial stability and growth remain high in the medium term."
Global elevated vulnerabilities in the corporate and non-bank financial sectors in several large economies could cause shocks, amplify the escalating trade tensions and, along with a no-deal Brexit, pose a threat to economic growth.
"Since the last edition of the GFSR in April, global financial markets have witnessed twists and turns of trade tensions and significant policy uncertainty. A deterioration in business sentiment, weakening economic activity, and intensifying downside risks to the outlook have prompted central banks across the globe, including the European Central Bank and the Federal Reserve, to ease policy", the report said.
According the report, investors have considered central bank actions and communications as a turning point in the monetary policy cycle.
About 70 percent of economies, weighted by GDP, have adopted a more accommodative monetary stance and a sharp decline in longer-term yields; in some major economies, interest rates are deeply negative.
Remarkably, the amount of government and corporate bonds with negative yields has increased to about $15 trillion.
Based on that, vulnerabilities among nonbank financial institutions, have risen since April and are now elevated in 80 percent of economies, by GDP, with systemically important financial sectors—a level similar to the height of the global financial crisis, as the report found.
"Very low rates have pushed institutional investors like insurance companies, pension funds, and asset managers to reach for yield and take on riskier and less liquid securities to generate targeted returns. For example, pension funds have increased their exposure to alternative asset classes like private equity and real estate", the report cited.
Consequently, similarities of investment funds portfolios could amplify a market sell-off, and illiquid investments by pension funds could constrain their traditional stabilizing role in markets. In addition, cross-border investments by life insurers could provoke spillovers across markets, as the report found.
Moreover, the report explained, external debt is rising among emerging and frontier economies as they attract capital flows from advanced economies, where interest rates are lower. Median external debt has risen to 160 percent of exports from 100 percent in 2008 among emerging market economies. A sharp tightening in financial conditions and higher borrowing costs would make it harder for them to service their debts, the report said.
In addition, stretched asset valuations in some markets are also contributing to financial stability risks. Equity markets appear to be overvalued in the United States and Japan. In major bond markets, credit spreads, as the compensation investors demand to bear credit risk, what seems to be too compressed relative to fundamentals, according the report.
In dealing with these risks and threats, the report proposed corporations that have debt-at-risk to follow a stricter supervisory and macroprudential oversight, including targeted stress testing of banks and prudential tools for highly levered firms, urging the Institutional investors to strengthen oversight and enhance disclosures through doubling efforts to mitigate leverage and other balance-sheet mismatches.
And for emerging and frontier markets, they have to adopt prudent sovereign-debt management practices and frameworks, as the report called on.