The S&P 500 has rallied more than 35% from its pandemic low in late March through last week, even as virus deaths mounted, the U.S. locked down and the unemployment rate soared. The IMF said that such rallies have occurred in past periods of significant economic pressure, only to quickly unwind. Credit spreads for investment-grade companies in advanced economies also are narrower than during past economic shocks, the fund said.
“This divergence raises the specter of another correction in risk asset prices should investors’ attitude change, posing a threat to the recovery,” Tobias Adrian, director of the IMF’s monetary and capital markets department, and Fabio Natalucci, the deputy director, said in a blog post accompanying the Global Financial Stability update on Thursday.
A sell-off could add financial stress on top of a recession that’s already projected to be the worst since the Great Depression.
The fund also warned that high debt levels may become unmanageable for some borrowers, with insolvencies and resulting losses testing bank resilience. Emerging- and frontier-market economies face refinancing risks, and authorities should closely monitor financial vulnerabilities while continuing to safeguard stability, the Washington-based lender said.
The IMF on Wednesday downgraded its outlook for the coronavirus-ravaged world economy, projecting a significantly deeper recession and slower recovery than it anticipated just two months ago. The fund said it now expects global gross domestic product to shrink 4.9% this year, compared with the 3% predicted in April.
Central banks in advanced economies have cut interest rates to about or below zero to buffer the effect of the coronavirus. While that along with the extensive use of tools such as quantitative easing has “restored confidence and boosted investor risk taking,” Adrian and Natalucci urged policy makers “to be attentive to possible unintended consequences, such as a continued buildup of financial vulnerabilities in an environment of easy financial conditions.”
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