International Monetary Fund Global Financial Stability Outlook Fabio Natalucci Deputy Director Monetary and Capital Markets Department 1
Financial Stability Risks Could Rise Sharply Since the April 2018 GFSR • Global financial conditions have tightened somewhat, but remain broadly accommodative • Near-term risks have increased Risks Could Rise Sharply modestly, while medium-term risks remain elevated Possible triggers: • Broader EM pressures Vulnerabilities • Escalation of trade tensions Continue to Build • Political and policy uncertainty • Faster monetary policy normalization • High nonfinancial leverage • Stretched asset valuations • EM external borrowing • Bank exposures & FX funding 2
MARKET DEVELOPMENTS 3
Financial Conditions Have Diverged Across AEs and EMs … offsetting tighter financial conditions …supporting near -term growth, while Financial conditions in the US eased, despite policy rate hikes… in EMs, and… keeping medium-term risks elevated Global Growth Forecast Densities US Financial Conditions Index and Financial Conditions Indices of Other (Probability density, 2018:Q3) Federal Funds Rate Advanced and Emerging Market Economies (z-scores over 2010-18 and percent) (z-scores over 2010-18) 1.0 2.0 2.5 2.0 Tighter conditions Tighter conditions Near term 0.9 Medium term 1.5 1.5 Last GFSR Last GFSR 0.8 2.0 1.0 1.0 0.7 0.5 0.5 1.5 0.6 0.0 0.0 0.5 1.0 0.4 -0.5 -0.5 5th percentile 0.3 -1.0 -1.0 0.5 0.2 -1.5 -1.5 0.1 0.0 -2.0 -2.0 0.0 2015 2016 2017 2018 2015 2016 2017 2018 -1 0 1 2 3 4 5 6 Global growth rate (percent) Federal Funds Rate (lhs) FCI (rhs) AE ex. US China EM ex. China Note: Assessment of financial conditions is based on findings of the Global Financial Stability Report – October 2018 4
Recent Market Movements Have Contributed to Tighter Conditions … leading to a significant fall in equity The sharp selloff in US stocks triggered a global stock market correction… valuations Major Stock Index Performance 12-month Forward Price-to-Earnings Ratio (index to Jan 1, 2018; YTD change in parentheses) (z-score since 1987; current value in parentheses) 1.0 110 0.5 100 0.0 -0.5 90 -1.0 -1.5 US (3.5%) Europe (-8.8%) US (15.3) Europe (11.9) Japan (-9.3%) EM (-12.2%) Japan (12.3) EM (10.2) 80 -2.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2012 2013 2014 2015 2016 2017 2018 5
Markets Are Pricing in a Benign Macroeconomic Outlook … despite relatively benign expectations Policy rate expectations point to gradual rate hikes… of future inflation Overnight Indexed Swap (OIS) Forward Rate Curves for Breakeven Swap Rates, 5Y5Y Forward (Percent) Advanced Economies (Percent) 6 4 Average 5 Maximum 3 4 Minimum 3 2 2 1 1 0 0 -1 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD JPY -1 USD EURO -2 Note: Annual average three-month overnight indexed swap (OIS) rates on forward 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 contracts for tenors from six months to five years. The OIS forward curves are constructed from the USD, EUR, JPY, and GBP, and the average, maximum, and minimum are computed for each tenor across the four jurisdictions. 6
In Certain Asset Classes, Valuations Still Increasingly Stretched …but corporate spreads remain very low, given Term premiums are low, but mostly fairly priced based on fundamentals… creditworthiness of borrowers Credit Spreads on US Investment Grade and Deviation from Fitted 10-Year Premium High Yield Corporate Bonds (Percentage points) (Spread over US Treasury in basis points, Yield on GE bond in percent ) Bps % 2.00 2500 7.0 Deviation from weighted- Max-Min of the range average fitted value 1.50 6.0 2000 1.00 5.0 0.50 1500 4.0 0.00 3.0 1000 -0.50 2.0 -1.00 500 1.0 -1.50 0 0.0 2006 2009 2012 2015 2018 US IG Spread US HY Spread GE 5-Yr USD Sr. Secured (RHS) 7
Intensifying Risks in Leveraged Lending … as has been the issuance of such … with fewer investor protections and Global new issuance of leveraged loans has been growing… loans by highly indebted companies… lower overall quality Covenant Quality New Issuances of Leverage Loans Leverage Multiple (Billion of US Dollars) 900 90 Covenant-lite percent of new 4.5 US Issuers issuance (left scale) 800 80 Non-US Issuers Moody's Loan Covenant Quality Index score (right scale) 4.0 700 70 600 60 3.5 500 50 Highe gher r Scor core e 400 Equals s 40 Weake ker r Covena enant nts 3.0 300 30 200 20 2.5 100 10 0 0 2.0 07 08 09 10 11 12 13 14 15 16 17 18 Note: Moody’s Loan Covenant Quality Index score is Note: 2018 data is through Q3 and annualized to Note: Leverage multiple is defined as the ratio of total estimate full-year 2018 issuance. debt-to-earnings before interest, taxes, depreciation and a year average. Data unavailable from 2008 to 2010. 8 amortization after issuance of the loan. 2018 data is through Q3.
Portfolio Flows to EMs Have Been Under Pressure Some moderation in EM portfolio flows is expected EM portfolio flows have declined, driven by due to ongoing US monetary policy normalization a reversal in retail fund flows Baseline: Estimated Cumulative Impact of External EM Portfolio Flows by Investor Type Factors on Portfolio Flows to EMs (US$ bn, 3-month rolling sum) (US$ bn) 20 150 Total flows 0 120 Institutional flows -20 90 60 -40 Estimates through 2018Q3 30 -60 0 -80 -30 Baseline Outlook Retail flows -100 -60 Risk aversion (assumed to stay at 2018:Q3 level) Taper EM Renminbi -120 U.S. election Fed balance sheet (from Federal Reserve) tantrum Sell-off -90 devaluation Fed rates (consistent with WEO) -140 -120 2017Q4 2018Q2 2018Q4 2019Q2 2019Q4 2013 2014 2015 2016 2017 2018 9
Investors Have So Far Differentiated Among EMs … but outsized FX currency moves have been limited Lower-rated EMs have seen larger widening in external debt spreads… to a few countries EM and AE Currencies against the USD USD Government Bond Spreads (index, 3/30/18=100) (changes since end-March; basis points) 105 China Advanced economies Oil exporters Poland A Chile All EMs High spread EMs 100 Malaysia Peru 95 Kazakhstan Philippines Colombia 90 BBB Hungary Russia 85 Indonesia Mexico 80 Brazil South Africa BB Turkey Depreciation against 75 the dollar Egypt Nigeria 70 Ukraine B Argentina 65 Lebanon Apr May Jun Jul Aug Sep Oct Nov Dec -50 0 50 100 150 200 250 300 350 400 Note: “High spread EMs” include Argentina, Brazil, South Africa, and Turkey; “Oil Note: Letters refer to foreign currency long-term sovereign credit ratings, as assigned exporters” include Colombia, Kazakhstan, Mexico, and Russia. by at least two out of the three major credit rating agencies 10
EM Policy Responses to Market Pressures Have Varied EM policy responses have included policy rate hikes… …and foreign exchange market interventions Reserves Operations Changes in Actual and Expected Policy Rates (US$ bn) (changes from 3/30/18 to 11/07/18; basis points) 50 350 1682 Change in forward policy rate for 300 3275 1125 end-2019 250 25 Change in actual policy rate 200 150 0 100 50 -25 Latin America 0 EM Asia -50 CEEMEA -100 -50 14 EMs excluding China -150 Brazil China Malaysia Poland Colombia Thailand Chile Romania India Hungary Philippines South Africa Indonesia Mexico Turkey Russia Argentina -75 Oct-14 Jul-15 Apr-16 Jan-17 Oct-17 Jul-18 11 Note: In Argentina, the monetary regime was changed on October 1.
Frontier Markets Face Challenging External Borrowing Conditions Some countries have large rollover More low-income countries are External borrowing conditions needs over the medium term at risk of distress have deteriorated Frontier Issuers’ International Frontier Market International Bond Low-income Countries Face Debt Issuance and Spread Bond Redemptions Challenges (US$ bn and bps) (US$ bn) (percent share of all LICs) 18 Frontier spread 12 550 60% Africa (bps, right scale) In debt distress Latin America 16 High risk of debt distress 10 500 50% Asia 14 Europe 8 450 40% Middle East 12 10 6 400 30% 8 4 350 20% 6 2 300 4 10% 2 0 250 0% May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 0 2019 2020 2021 2022 2023 2024 12
FINANCIAL VULNERABILITIES 13
Non-financial Sector Debt Vulnerabilities Continue to Rise Non-financial sector leverage has increased since the global financial crisis and is high in some regions, while banking sector leverage has broadly improved Leverage Heatmap: 2018 (percentile ranks; pooled sample, 2000 or earliest available to 2018) < 20% 20-40% 40-60% 60-80% > 80% REGIONS United States Euro area Other AEs China Other EMs Corporates Households S E Sovereigns C T O Banks R S Insurers Asset managers Note: the heatmap is based on the data for 29 jurisdictions with systemically important financial sectors. 14
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