Monetary tightening in the US threatens to expose financial excesses and vulnerabilities that could wipe trillions of dollars off bond markets, the International Monetary Fund warned yesterday.

If the Federal Reserve's likely move to start scaling back its asset purchases or fallout from a possible US failure to lift its ceiling on public debt raise long-term interest rates by 1 percentage point, the IMF's Global Financial Stability Report estimates that the market losses on bond portfolios could reach $2.3 trillion.

Stability risks
In a world of heightened financial stability risks, demonstrated by the flight to safety from emerging markets in the summer, the fund is concerned that large elements of the world's financial system remain vulnerable to stresses that might ensue as the extraordinary policies of the post-crisis period are scaled back.

'Substantial challenge'
Describing the process of normalising US monetary policy as "unprecedented and complex", José Viñals, financial counsellor to the IMF, said that "containing longer-term interest rates and market volatility has already proven to be a substantial challenge".

The fund estimates the potential damage from a spike in long-term bond yields from investor fire-sales, a loss of liquidity in certain markets such as real-estate investment trusts and contagion could lead to large losses.

In addition, the fund’s report warned that if the US were to default on some of its obligations after a failure to raise its debt ceiling, it “could seriously damage the global economy and financial system”. – (Copyright The Financial Times Limited 2013)