IMF report raises concerns about financial stability

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What's going on?

The IMF released its enticingly titled Global Financial Stability Report. It doesn’t exactly make for happy reading. It raises concerns about what will happen if the US central raises interest rates later this year as expected and how quantitative easing in Europe may cause problems.

What does this mean?

One concern they raise is that emerging markets have raised significant debt in US dollars that would incur higher interest payments. All major emerging markets have had a greater growth in debt than GDP since 2007, putting them in a more precarious financial position. Another concern is the potential mismatch between short-term central bank interest rates and long-term interest rates in the bond markets. The mismatch would be due to quantitative easing. Under this programme, the US central bank has effectively bought a huge amount of bonds in the market. Like any market intervention, this could potentially distort how the market functions. This distortion might force the central bank to raise short-term rates even more than it wants to in order to force long-term rates up. In parallel, the IMF also raises concerns about Europe. Insurers have previously sold policies that offer generous returns. Those returns are no longer supported by the market because the quantitative easing programme recently introduced in Europe has lowered the interest rates that pay for those insurance policies.

Why should I care?

We are essentially in unchartered territory. This is the first time in nearly a decade that the US is increasing interest rates above zero percent. Meanwhile central banks are running quantitative easing programmes that are entirely unprecedented. How this all plays out is not clear, not even to the IMF or the all-mighty markets, so there is a risk that things go wrong and the average person becomes affected economically. As an investor, you would do well to keep a buffer so that you can withstand short-term volatility. One of the hallmarks of financial turbulence is that liquidity disappears. What does that mean? People become too scared to buy or sell so the market disappears. That’s a bad time to be a forced seller. So to avoid those situations you do well to keep a bit of cash in your pocket and avoid going all out on the most enticing deals.
Originally posted as part of the Finimize daily email.

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