Investors should take note of the small print in the IMF’s rosy economic forecast

Thomson Reuters

  • The International Monetary Fund has revised up its forecasts for global economic growth.
  • The IMF cited “increased global growth momentum and the expected impact of the recently approved US tax policy changes” for its fresh optimism.
  • However, the rosier outlook came with a major caveat for financial markets, which the IMF warned could be at the risk of a confidence-shaking correction.

The International Monetary Fund’s upgrade of its global economic growth forecast came with a major caveat: Bubbly financial markets are at risk of popping, and that could take a toll on world’s economy.

The IMF revised up its predictions for global economic growth in 2018 and 2019 by 0.2 percentage points, to 3.9%, citing “increased global growth momentum and the expected impact of the recently approved US tax policy changes.”

The IMF warned, however, that the recent rallies across financial markets, ranging from stocks to corporate bonds, were a reason to worry.

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International Monetary Fund

“Rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence,” the IMF said.

The IMF was referring in part to the phenomenon of a flat yield curve, where rates on longer-term bonds – supposed to be substantially higher than those of their short-term counterparts to reflect the greater risk of lending over longer periods – slip closer to rates on short-term bonds.

Some investors and policymakers worry that the trend, especially glaring in the US Treasury market, reflects expectations for weak investment returns over a prolonged period. An inverted yield curve, where long-term rates slip below short-term ones, has in the past been a reliable predictor of recessions.

“If global sentiment remains strong and inflation muted, then financial conditions could remain loose into the medium term, leading to a buildup of financial vulnerabilities in advanced and emerging market economies alike,” the IMF said.

Risks will mount as long as “yield-seeking investors increase exposure to lower-rated corporate and sovereign borrowers and less creditworthy households,” it added.