IMF: Fed Tapering Could Wipe $2.3 Trillion Off Bond Markets

By Mani
Updated on

The IMF has warned that investors could be facing a potential loss of $2.3 trillion (£1.44 trillion) if central banks fail to smoothly unwind the emergency measures carried out during the financial crisis.

The IMF, in its Global Financial Stability Report published today, put a number on the potential impact of messy quantitative unwinding.

Series of initiatives from global bankers

The IMF report highlights a series of initiatives contemplated by various bankers. For instance, IMF points out the U.S. may soon move to less accommodating monetary policies and higher long-term interest rates as its recovery gains ground.

Japan is moving toward the new ‘Abenomics’ policy regime, while the Euro area is moving toward a more robust and safer financial sector.

The emerging markets face a transition to more volatile external conditions and higher risk premiums.

The global banking system is phasing in stronger regulatory standards.

IMF: Bumps in the road to monetary normalization

The IMF report points out that the primary challenge for policymakers is managing the current side effects and the eventual withdrawal of easy money policies such as low interest rates and bond buying by the U.S. Central Bank.

The report points out that in the event of increasing interest rates and enhanced volatility, investors will naturally adjust their portfolios by reducing their fixed income holdings. The IMF report cautions that by selling too much too fast, the long-term interest rates would rise more sharply than currently anticipated.

This would result in bumps in the road to monetary normalization, the report warns.

Substantial inflows into fixed income mutual funds

The report also highlights that since 2009, the cumulative U.S. mutual fund inflows into fixed income have exceeded their historical trend by over $5 trillion. The report cautions that this has raised the risk of large withdrawals in the event of monetary tightening.

The IMF report estimates that since 2008, cumulative foreign inflows into emerging market’s bonds have exceeded their long-term structural trend by about $470 billion. The report suggests in the event of significant capital outflows, policy buffers may have to be used wisely by the emerging market’s central bankers.

For the first time, the IMF has put a number on the potential impact of a messy end to quantitative easing. It estimates the market losses on bond portfolios could touch $2.3 trillion.

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