The IMF’s $3.8 trillion warning to the Fed

Published: Oct 8, 2014 9:00 a.m. ET

WASHINGTON (MarketWatch) — A rocky exit from low interest rates by the Federal Reserve risks $3.8 trillion of losses to global bond portfolios, the International Monetary Fund warned Wednesday in its latest global financial stability report.

The IMF was at pains to emphasize that it’s not forecasting such losses, but it did point out that tightening in the past has been a key trigger for declines in fixed-income markets.

The IMF came up with the $3.8 trillion figure by assuming a rapid adjustment that causes term premiums to go back to historic norms and credit risk premiums to normalize, with moves of 100 basis points each. That would trigger losses by more than 8%, which could “trigger significant disruption in global markets.”

The IMF also pointed to the low volatility term structure for the S&P 500, suggesting equities also may be underpricing the risk of higher volatility in the future.

It’s these concerns that have led the Federal Reserve to increase their communication to the public, through quarterly press conferences as well as interest-rate and economic forecasts.

Observers both inside and outside the Fed expect the first rate hike to occur in the middle of 2015. But there remains considerable debate over the pace of subsequent hikes.

Meanwhile, while the IMF warned about the Fed lifting interest rates, they also note the risks of the Fed and other central banks keeping rates low for so long. The IMF pointed out that asset price appreciation, spread compression and recovery low volatility have occurred simultaneously across broad asset classes and countries.

Link….

http://www.marketwatch.com/story/the-imfs-38-trillion-warning-to-the-fed-2014-10-08

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