Summer markets rout raises fears of potential shocks, senior IMF official says

The global equities rout this summer is a reminder of how underlying tensions can lead to abrupt episodes in asset repricing, an executive at the International Monetary Fund has said.

Major US indexes have remained formidable this year, riding disinflationary vibes, the beginning of US interest rate cuts and marquee tech earnings. The S&P 500 and Dow Jones Industrial Average reached record highs last week before closing at 5,864.67 and 43,275.1, respectively. The Nasdaq Composite also ended Friday in the green, joining the two other indexes in clinching six consecutive weeks of gains.

Despite market optimism and interest rate cuts subduing financial market volatility, uncertainty remains twofold, said Tobias Adrian, director of the IMF's monetary and capital markets department. Part of this uncertain outlook is due to geopolitical tensions and the rise in global fragmentation.

“We, of course, still have two major conflicts in the world,” said Mr Adrian, referring to the wars in the Middle East and Ukraine. The increase in trade restrictions has also led to broad fragmentation, he said.

“So, we worry that that kind of underlying tension could give rise to abrupt episodes of repricing if adverse shocks realise – and we saw a little bit of that in early August,” Mr Adrian told The National in an interview during the IMF and World Bank annual meetings in Washington on Monday.

A mixture of disappointing US employment data and the Bank of Japan's decision to raise interest rates by 25 basis points led to a brief period rocked by market volatility.

Technology-driven markets in Taiwan and South Korea suffered, while markets in the Middle East also slipped. Major US indexes fell as well, with the Dow Jones Industrial Average and Nasdaq Composite Index suffering their biggest losses in almost two years.

While trading since the early-August rout shows the episode was “more like a blip in retrospect”, it demonstrates there is a potential for sharp sell-offs, Mr Adrian said.

Japan's Nikkei index faced its largest single-day increase since 1997, falling 12 per cent after trading stopped three times on August 5. The US volatility index, meanwhile, soared to over 60.

“That is very notable, and it raised this question whether we could see this kind of sharp and, in some ways, non-linear reaction relative to certain shocks,” Mr Adrian said.

“We do worry that we could see a sharp sell off in risk asset markets,” Mr Adrian said. “I think what leaves us a little bit uncomfortable is that it's hard to say, what are the shocks that could be the trigger?”

Elections and economic uncertainty

Mr Adrian said the other side of the uncertainty is the shifting of policies by newly elected governments. This has been a historic voting year, with elections in 50 countries and a projected two billion people heading to the polls.

“That has created already some shifts in policy and may create further shifts in policy, so it's creating a baseline of uncertainty," he said.

Mr Adrian did not specify when asked how the US election – with voting two weeks away – weighs on this, instead pointing to “broader uncertainty”.

“There's a wide range of possible outcomes, and that is certainly playing into financial markets and broader economic expectations and ultimately behaviours,” he said.

“How it's going to play out, I think, is not known at this point. So, what we emphasise is the uncertainty related to the elections.”

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