Near-term global financial risks are contained, but monetary policy easing could fuel asset price bubbles and markets might be underestimating risks posed by military conflicts and impending elections, the International Monetary Fund said.

In its semi-annual Global Financial Stability Report, the IMF warned that a "widening disconnect" between escalated geopolitical uncertainty and low market volatility increases the chance of a market shock similar to the gyrations seen in August when a Bank of Japan interest rate hike sparked massive de-leveraging.

Buoyant credit and equity markets also seem undeterred by a slowdown in earnings growth and the continued deterioration in more fragile segments of the corporate and commercial real estate sectors, the Washington-based multilateral lender said.

It also flagged that while monetary easing by most other major central banks was creating "accommodative" financial conditions, interest rate cuts could stoke lofty asset valuations, a global rise in private and government debt, and non-bank leverage.

"These mounting vulnerabilities could amplify adverse shocks, which have become more probable due to elevated economic and geopolitical uncertainty amid ongoing military conflicts and the uncertain future policies of newly elected governments," it wrote.

The report was released as global finance chiefs gather in Washington for the IMF and World Bank annual meetings during one of the most geopolitically and economically uncertain periods for the world in decades.

In addition to the war in Ukraine and an escalating conflict in the Middle East, half the world's population has elected or will elect new governments in 2024, including the US, the IMF noted. In many cases those new leaders' policy plans are unclear, but will carry significant economic consequences.

In particular, economists and Wall Street executives have raised concerns that Republican presidential candidate Donald Trump's planned import tariff hikes could reignite inflation, while his promised tax cuts could widen the US deficit.

The IMF urged central banks to communicate clearly and cut rates gradually, and said regulators should closely monitor corporate debt and commercial real estate, and ensure robust bank supervision. It also said regulators should enhance reporting requirements for non-bank financial institutions like hedge funds and private equity firms, which are playing a bigger role in financial markets. Regulators, however, generally have less visibility on such firms' activities and leverage levels compared with traditional lenders, the report said.

The rise of artificial intelligence also featured in the report. The IMF noted that increased adoption of AI by financial firms could boost speed and efficiency, but also volatility.

Furthermore, increased reliance on a handful of AI service providers poses other operational risk, and could create a challenge for regulators trying to police what is generally seen as a more opaque technology, the report said.

Source: The edge markets

Benchmark Treasury yields may soon hit a key level on the back of rising inflation expectations and concerns over US fiscal spending, according to T Rowe Price.

“The 10-year Treasury yield will test the 5% threshold in the next six months, steepening the yield curve,” according to Arif Husain, chief investment officer of fixed-income, who helps oversee about US$180 billion (RM774.43 billion) of assets at the firm. The fastest path to 5% “would be in the scenario that features shallow Fed rate cuts,” he wrote in a note.

The call stands out against market expectations of lower yields, after the Federal Reserve cut rates for the first time in four years last month. It also underscores the increasing debate in the world’s biggest bond market, following strong economic data that has raised questions about the likely pace of cuts.

Yields on 10-year Treasuries most recently traded at 5% last October, hitting their highest level since 2007 as fears of a prolonged period of high interest rates gripped markets. Turbulent repricing could be on the cards if Husain’s prediction proves accurate, with strategists currently expecting yields to fall to an average 3.67% in the second quarter. 

Husain, a near three-decade market veteran, said ongoing issuance by the Treasury to fund the government deficit is “flooding the market” with new supply. At the same time, the Federal Reserve’s policy of quantitative tightening — an attempt to reduce its balance sheet following years of bond-buying — has removed a key source of demand for government debt.

The yield curve is likely to steepen further because any rises in the yields of short-maturity Treasury bills will be limited by rate cuts, said Husain, who is also T Rowe Price’s head of fixed income.

Deutsche Bank’s private banking arm said last month that 10-year Treasury yields would touch 4.05% by next September, a prediction that took only around a month to prove correct. Blackrock Investment Institute, meanwhile, issued a report last week telling investors to expect yields on longer-term US debt to swing in both directions as new economic data is released.

Cracks are already appearing in the US’s fiscal position, lending credence to Husain’s views. The country’s debt interest-cost burden climbed to its highest level since the 1990s in the financial year that ended in September, but neither former president Donald Trump nor Vice President Kamala Harris has touted reducing the deficit as a key element of their campaign. That has left US government debt a key risk for market participants. 

The most likely scenario for the Federal Reserve is a period of small rate cuts, comparable to its reductions between 1995 and 1998, said Husain. In this scenario, China would inject more stimulus to help its own economy, boosting global growth and creating a clearer outlook for Fed officials.

There are also prospects of a normal easing cycle where the Fed cuts to nearer to the neutral rate, which Husain said is probably around 3%. He also considered a scenario in which the US went into recession, which would spur aggressive cuts. 

“Investors sharing my view that a near-term recession is unlikely should consider positioning for higher long-term Treasury yields,” Husain wrote. 

Source: The edge markets

Europe's data center power consumption is expected to almost triple by 2030 and will require a surge in electricity—supply mostly from low-carbon sources coupled with grid infrastructure upgrades, McKinsey has reported. According to the global business management consultant, total IT load demand for data centers in the European Union, Norway, Switzerland and Britain will hit 35 gigawatts (GW) by 2030, up from 10 GW today.

Europe's data centers are expected to account for ~5% of the continent's total consumption over the next six years compared to around 2% today. McKinsey estimates that Europe will require $250-300 billion in data center infrastructure investment, excluding power generation capacity.

"Meeting (the rise in electricity) demand will require an extensive increase in electricity supply; a notable shift for Europe, where aggregate power demand has remained relatively stagnant since 2007," the McKinsey report said.

But the surge in data center power consumption will not be confined to Europe alone. Last year,  the power sector consulting firm Grid Strategies published a report titled "The Era of Flat Power Demand is Over," which pointed out that United States grid planners--utilities and regional transmission operators (RTOs)--had nearly doubled growth projections in their five-year demand forecasts. For the first time in decades, demand for electricity in the U.S. is projected to grow by as much as 15% over the next decade, driven by the Artificial Intelligence (AI), clean energy, and cryptocurrencies boom.

AI, in particular, is expected to drive a lot of that surge in power demand. According to the Electric Power Research Institute (EPRI), data centers will gobble up as much as 9% of total electricity generated in the United States by the end of the decade, up from ~1.5% currently thanks to the rapid adoption of power-hungry technologies such as generative AI. For some perspective, last year, the U.S. industrial sector energy consumed 1.02 million GWh, good for 26% of U.S. electricity consumption.

Source: OILPRICE