S equity markets warning from IMF
The International Monetary Fund has warned the US equity market risks
suffering a sharp correction which could destabilise world markets. In its
annual International Capital Markets report, the IMF said emerging markets
were particularly vulnerable due to reliance on capital flows and borrowings
from the West. The recent benign inflation data from the United States,
which last week showed only a very slow rise in last month's jobs figures,
could prove to be a false dawn in the Federal Reserve's battle against
inflation, the report said. "The unusually favourable inflation performance
during the past few years [has] . . . led some market participants to
underestimate the extent of tightening that may be eventually needed," it
said. The IMF noted that the Federal Reserve said after the last rate rise
in June that it would remain vigilant for any further signs of inflation.
The fund warned an additional rise in interest rates would cause problems
for emerging markets. "Historically, a tightening of monetary conditions in
mature markets has often been accompanied by a slowdown in capital flows to
emerging markets and a widening of interest-rate spreads in emerging markets
securities," it said. "Recent empirical studies suggest that a rise in
mature market interest rates not only raises the base cost for emerging
market borrowing but also increases the spread on that borrowing, and that a
tiering of issuers tends to take place [with less creditworthy borrowers not
attempting to access global bond markets]." It said last year's global
market turbulence demonstrated how one shock - namely the forced devaluation
of the rouble and the subsequent collapse of the Russian economy - had
caused volatility in markets all over the world. "A steep correction in the
US equity market would likely have serious consequences in a similarly
leveraged system." Although the extent of lending and capital-flow movement
is thought to be considerably less in the present environment than was seen
last year, the IMF said there was no definitive data available. In the first
half of the year there was evidence some leverage channels had seen greater
activity - particularly the yen carry trade, where investors borrow funds in
yen at very low interest rates. "Absent comprehensive information about the
extent of leverage in the major financial systems, the vulnerability of
those systems and the emerging markets to a correction in the US equity
market may be considerable," the IMF said. A sharp correction in the dollar
- to reflect the growing US current-account deficit - or the global Y2K
problem - where the state of readiness in countries around the word is still
highly uncertain - also had the potential for creating destabilising forces
in markets. It said emerging markets generally were also undergoing a period
of adjustment, sparked off by the Russian debt restructuring. "As the number
of investors actively trading and holding emerging-market securities has
declined, liquidity in those markets has diminished, which has resulted in
higher bid-ask spreads and increased asset price volatility," the IMF said.
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