storm clouds seen over markets: imf
Storm clouds seen over markets: IMF 2006 seen as 'not bad' after stellar 2005 E-mail | Print | | Disable live quotes By Greg Robb, MarketWatch Last Update: 6:01 AM ET Apr 11, 2006
WASHINGTON (MarketWatch) -- After several years of low interest rates and ample liquidity, storm clouds are developing over global financial markets, according to a new report from the International Monetary Fund. Although the global financial system has gathered strength and resilience in 2005, "a number of cyclical challenges appear to be gathering on the horizon, which necessitates a more nuanced view of the financial outlook for the remainder of 2006 and beyond," the study, called the Global Financial Stability Report, concluded. Despite the worries, continuation of sunny skies was still the baseline forecast of IMF researchers. "The most likely cyclical setting for financial markets in 2006 could be defined as 'not bad, but not as good as the stellar year 2005,' the report concluded. But the storm clouds are mounting and questions remain about how fast they might arrive and whether financial systems will be able to handle any added stress. Developments in credit derivatives, which have distributed financial risks to a wide range of financial players instead of banks, increase the chance of "unpleasant surprises" from the less-regulated market players. The lure of U.S. assets For starters, the IMF said there should be some moderation in the pace of foreign accumulation of U.S. assets in 2006 because of stronger growth and higher interest rates in Europe and Japan. Foreign appetite for U.S. assets have been the key factor holding U.S. long-term interest rates low, cushioning the blow from the steady Federal Reserve rate hikes. There is a small risk that the slower accumulation of dollar assets could trigger a sharp fall in the dollar and push up interest rates, although it is more likely foreign appetite will "go on for some time," the IMF said. That is because a strong and liquid U.S. financial market is a key reason why foreigners send their money overseas and this advantage is not likely to diminish in the near-term, the report said. Other factors to monitor The benign financial environment may also be upset if inflation expectations were to increase significantly. Headwinds could develop through a rise in short and long-term interest rates or pressure on equity markets. "However, any [stock] market correction is unlikely to be very significant given that market valuations, measured by price-earnings ratios, are currently around their long-term averages in most countries -- meaning, they are not as stretched as they were in 2000 and therefore less vulnerable to a "bursting of the bubble." The report said there is evidence that the global credit cycle is turning, with less favorable investment conditions expected at the year unfolds. Developments in the U.S. housing market bear watching, with risks of a larger-than-expected fall in consumer spending. Judging from the experience of Australia and the United Kingdom, a drop in U.S. home prices would lead to a weakening of the economy. According to IMF estimates, a slowdown of U.S. home price appreciation from 10% last year to zero would reduce personal consumption by around 0.5-1 percentage point. But this could allow the personal savings rate to rise somewhat and contribute to a moderation of U.S. current account deficit. Another concern is that high interest rates could raise the debt-servicing burden of U.S. homeowners. The debt-service-to-income ratio for the household sector is already at a high level of 13.5%. But the report was sanguine on the issue of the flat yield curve, saying that several factors indicate it is not a sign of an impending recession in the United States
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