IMF warns of danger of disconnect between 'real economy' and financial markets

IMF warns of danger of disconnect between 'real economy' and financial markets

He notes that “market valuations appear to have stretched in many equity and bond markets,” which is a euphemistic way of saying there are financial bubbles.

IMF warns of danger of disconnect between 'real economy' and financial markets

“The Dow Jones' Best Week Since 1938”, “More Than 16 Million Americans Have Lost Their Jobs In Three Weeks.” The two headlines appeared at the same time on CNBC's financial television show Mad Money ( Crazy Money ) in early April. Since then, the divergence between the real economy and financial markets has grown, becoming one of the characteristics of this crisis.

Stock markets in developed countries have recovered 85% of their January levels on average, as shown in the Report on World Financial Stability published by the International Monetary Fund (IMF) this Thursday. Debt spreads have declined 70% from their March highs, and high-yield bonds – often known as the less charitable junk bond denomination – have returned to the market.

All this is due to a reason: the intervention of central banks. The markets discount that there will be zero interest rates for years. But the decoupling between the so-called 'real economy' and the 'financial' carries risks. “There is a divergence between the price of risk in financial markets and the economic outlook, as investors are apparently betting on continued and unprecedented support from central banks,” the report states.

The Fund does not hide its concern about this situation, which, in its opinion, has reached dangerous levels . “According to IMF models, the difference between asset prices and fundamentals-based valuations is close to historical highs in most advanced country bond and equity markets,” the report states. after stating that “market valuations appear to have stretched in many bond and equity markets.” It is a euphemistic way of saying that there are financial bubbles .

The fact that financial markets are not in trouble is good news. If having the worst crisis in 90 years is already problematic, it is better not to imagine what would happen if the financial sector were in bankruptcy as it happened in 2008 in the United States and Great Britain or between 2010 and 2013 in most of the Eurozone. The problem is that it is not clear that this will last.

There are many factors that can puncture these 'bubbles'. The most obvious, a deeper recession than expected (in fact, the Fund is much more pessimistic than the markets regarding the depth of the crisis), or a second wave of Covid-19, a minor stimulus from central banks what the market expects, or a resumption of the trade wars. If all that sounds very hypothetical, notice how yesterday Wall Street fell 2.72% yesterday with the news that the United States had broken its own record of 'positives' of the virus and that the Government of Donald Trump is preparing a new wave of tariffs against imports from Great Britain, Spain, France, or Germany.

If the markets 'prick', the economic problems derived from the coronavirus would multiply . For the time being, companies would have difficulty obtaining liquidity. It must be taken into account that private and family debt had already been growing at very high levels before the pandemic, so the market's vulnerability is considerable. That could trigger a wave of defaults and defaults that, in turn, hit banks, funds, and insurers. The result would be to add one more crisis to the one the world already has. Although at the moment it does not seem that this will happen, the Fund's warning is clear: the optimism of the financial markets is based on a fragile basis.

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