By Paul Hannon
A lengthy conflict in the Middle East could lead to further sharp declines in the prices of financial assets, and threaten the stability of the global financial system, the International Monetary Fund said.
The war has already roiled financial markets, with share prices around the world down 8% since the U.S. and Israel launched their first attacks on Iran in late February. Bond prices have also fallen significantly, leading to a rise in borrowing costs for governments, businesses and households.
In its twice-yearly report on the global financial system, the IMF warned Tuesday that the conflict could weaken stability in a variety of ways, highlighting vulnerabilities in the market for government bonds, developing economies, and artificial-intelligence-related equities.
"The longer the conflict continues, the greater the risk that global financial conditions could tighten further and more abruptly," the IMF said. "The financial system's resilience could be tested as several channels could amplify such tightening, leading to financial stability risks."
Those concerns echoed a letter from the head of the Financial Stability Board to finance chiefs from the Group of 20 largest economies that was released Monday.
"There is an increased likelihood that multiple vulnerabilities could crystallize at the same time, thereby amplifying the threat to financial stability and the provision of critical financial services," wrote Andrew Bailey, governor of the Bank of England. "I call this the risk of a double or triple whammy."
Borrowing costs for the governments of rich countries have risen since the Covid-19 pandemic, and many have responded by selling bonds with shorter maturities to keep their interest bills down. But that can create problems at times of turmoil.
"More concentrated issuance of shorter-term securities has made core sovereign bond markets more vulnerable to rollover risks-particularly in periods of rising inflation--which could accelerate the rise in bond yields," the IMF said.
The IMF also highlighted the vulnerability of developing economies to sudden outflows of capital, given that many will be hit hard by the rising cost of imported energy.
"Shifts in the composition of capital inflows to emerging markets have been moving toward more uneven, cyclical, and potentially volatile forms of financing," the Fund said.
As government debts have risen over recent years and central banks have stopped buying, hedge funds have played a bigger role in the market. However, many borrow to boost their returns, and a sharp rise in interest rates could place them in difficulty.
"An abrupt tightening of financial conditions can lead to forced selling by hedge funds, option sellers, leveraged exchange-traded funds, and other nonbank financial intermediaries that have expanded through leverage," the IMF said.
The conflict has pushed oil and natural-gas prices sharply higher around the world, and that is a challenge for the energy-intensive development of AI. The Fund said the threat to financial stability from increased costs at a time of huge investment needs has been heightened by what it called "circular financing arrangements" among companies involved in different parts of the AI industry.
"Greater interconnectedness owing to such circular financing structures heightens concerns of systemic spillovers should an adverse shock affect even a single entity," the IMF said.
With the conflict now in its seventh week, the IMF said governments and central banks should be prepared to step in to help financial firms that get into difficulty.
"Amid the ongoing war and financial market turbulence, authorities should prepare to deal with possible market dysfunction and limit the risk of destabilizing feedback loops," it said. "National authorities should be ready to intervene and ensure that central bank liquidity facilities are operationally ready, to be deployed swiftly to support market functioning during stress."
Write to Paul Hannon at paul.hannon@wsj.com
(END) Dow Jones Newswires
04-14-26 1029ET
