Financial Times - September 9, 1999
IMF fears global effects of US slowdown By George Graham, Banking Editor
The International Monetary Fund yesterday warned of the growing risk of a large correction in the US equity market that might spill over to other markets and create the sort of financial turbulence that swept the world a year ago.
In its annual report on capital markets issues, the IMF said: "The remarkably high level of valuations in the US equity market, reached after a nearly unprecedented period of gains, poses a risk in global financial markets."
Though many investors believe the rise in US share prices is justified, the Washington-based institution warned that the factors that had supported the market were no longer in force. The decline in interest rates had reversed, corporate profits growth was likely to slow, and the flow of money into mutual funds had slowed.
"The weakening of these supporting factors implies an increased vulnerability of US equity prices to shocks, including a sharper-than-expected tightening of monetary policy, weaker-than-expected growth in earnings, and a worsening of investor sentiment."
Fund economists dismissed the argument that recent gains were justified by the compression of the risk premium attached to equities relative to bond prices. They said this was hard to reconcile with the global trend, evident since last autumn's markets turmoil, in which investors have demanded bigger premiums for risk.
In all the other Group of Seven leading industrial countries, the IMF says, the surge in share prices can be more of less fully explained by today's low interest rates.
The IMF's concerns about the risk to the international financial system are heightened by its assessment of weaknesses in several big banking industries.
After a decline in profitability last year, there were signs that banks were attempting to resist a further deterioration in returns by taking on more risk, especially in the US.
The millennium bug was also a cause for concern. While the risk to banks' own computer systems now appeared to be minimal, they could still face disruption if their large customers were significantly affected or if worries about the effect of the year 2000 date change, justified or not, caused liquidity squeezes in markets.
The report accepts that the controversial foreign exchange and capital controls imposed last year by Malaysia might have been justified. Concerns expressed by countries such as Malaysia about concerted attacks on their currencies by hedge funds "cannot be easily dismissed".