The global economy seems to be experiencing a soft landing scenario. Thanks in large part to the strength of the United States, a global recession has been avoided and inflation has eased. Both investors and central banks are expecting monetary policy to relax in the coming quarters, but the battle is not yet won. The International Monetary Fund (IMF) warns in its financial stability report published this Tuesday of the lurking risks.

The IMF’s financial department, led by Tobias Adrian, has already highlighted the risks associated with commercial real estate (CRE) loans in the United States in a report published last month. Now, they are emphasizing the message once again. “There is still a subgroup of banks with exceptionally high credit risk concentration for which losses could compromise their safety and soundness,” they warn.

“A third of U.S. banks, mainly small and medium-sized ones, with $3.7 trillion in total assets, reported CRE exposures exceeding 300% of their level 1 capital plus loan loss provisions, including a large non-systemic bank that surprised its shareholders by reporting significant provisions for losses on CRE-related loans in its fourth quarter 2023 earnings release,” they point out, referring to the New York Community Bancorp, which has been on the brink.

The IMF includes in its report a chart of 20 countries with significant exposure to the commercial real estate sector. The bad news for Spain is that it is on the list. The good news is that it ranks 19th, with an exposure representing only 5% of credit on total loans, less than a third of the United States (18%), half of Germany or Japan, and also less than Italy, France, or the United Kingdom. The most exposed financial systems are Cyprus, Malaysia, South Korea, Latvia, Bulgaria, and the United States. China deserves a separate mention, where the IMF points out that it is essential to adopt strong policies to restore confidence in the real estate sector as a whole.

“While the banking sector appears well positioned to absorb CRE losses overall, some economies could suffer painful losses, given the sector’s large size and its interconnectedness with the financial system and the economy as a whole,” warns the Fund. “This is especially true in the United States, where CRE debt is estimated at nearly six trillion dollars,” they conclude.

The report emphasizes that commercial real estate prices in the United States have experienced steeper declines during this interest rate hike cycle than in almost all previous cycles. Securing and refinancing commercial mortgages remains difficult due to still high interest rates, reduced property values, and banks’ risk aversion. According to analysts’ estimates, of the trillion dollars of debt maturing in the U.S. CRE market in 2024 and 2025, the refinancing shortfall exceeds $300 billion, the report indicates.

### Interest Rate Concerns

The other risk to financial stability highlighted by the IMF comes from the possibility that the base scenario, in which inflation falls to price stability targets and interest rates begin to decline before the end of the year, may not materialize. “The fact that global inflation remains persistently above those stability targets could call this narrative into question and trigger instability. Recent fluctuations in underlying inflation in some countries are a good reminder that the disinflation effort is not yet complete,” explains the IMF.

The report emphasizes that market volatility seems too low compared to the high levels of macroeconomic uncertainty. It also highlights that the valuations of many risky assets are increasingly tight, based on investors’ expectations of relatively rapid monetary easing that may be tested by bumps in the road.

“Inflation surprises to the upside, for example, those caused by commodity price spikes and supply chain disruptions, could call into question the benign disinflation narrative prevailing in markets and among policymakers,” they warn.

The IMF notes that investors are still pricing in interest rate cuts by the end of the year of 0.75 points in the eurozone and 0.50 points in the United States. “Investors seem to trust that data-dependent central banks will relax monetary policy when inflation slows further. But if inflation remains high, these lofty expectations could be dashed, leading to a correlated sell-off of assets, from bonds to stocks and crypto-assets,” they caution.

“The overall outlook for global macro-financial stability risks has improved over the past year, along with declines in global inflation. However, policymakers must remain vigilant and plan measures not only in the base scenario but also in adverse scenarios. Since the outbreak of the COVID-19 pandemic in 2020, financial sectors and economies have been affected by a series of adverse disruptions, and new setbacks could materialize. Only prudent policy and alert preparedness will ensure that potential future scenarios can be effectively addressed,” concludes Tobias Adrian, the Fund’s financial head.

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