Disconnect between financial markets, real economy could pose threat to recovery: IMF

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WASHINGTON, June 25 (Xinhua) -- The International Monetary Fund (IMF) warned Thursday that the ongoing disconnect between financial markets and the real economy is a "vulnerability," which could pose a threat to the recovery should investor risk appetite fade.

Major central banks around the world have contributed to the "substantial easing" of financial conditions via interest rate cuts and a balance sheet expansion of over 6 trillion U.S. dollars, including asset purchases, foreign exchange swap lines, and credit & liquidity facilities, the IMF said in an update to its April Global Financial Stability Report.

"These swift and unprecedented actions by central banks have restored confidence and boosted investor risk taking," Tobias Adrian, financial counsellor and director of the IMF's Monetary and Capital Markets Department, and Fabio Natalucci, deputy director of the department, wrote in a blog.

"After sharp declines in February and March, equity markets have rallied back, in some cases to close to their January levels, while credit spreads have narrowed significantly, even for riskier investments," the IMF officials said, noting that there has been "an apparent disconnect" between financial markets and economic prospects.

"Investors seem to be betting that lasting strong support from central banks will sustain a quick recovery even as economic data point to a deeper-than-expected downturn," they said.

The disconnect between financial markets and the real economy can be illustrated by the recent decoupling between the soaring U.S. equity markets and plunging consumer confidence, "raising questions about the rally's sustainability if not for the boost provided by central banks," they said.

The IMF officials noted that this divergence raises the specter of another correction in risk asset prices should investors' attitude change, posing a threat to the recovery.

A number of developments could trigger a decline in risk assets' prices, including a deeper and longer-than-anticipated recession, a second wave of infections with ensuing containment measures, as well as geopolitical tensions or broadening social unrest in response to rising global inequality, they said.

They added that expectations about the extent of central banks' support could turn out to be too optimistic, leading investors to reassess their appetite and pricing of risk.

"Such a repricing, especially if amplified by financial vulnerabilities, could result in a sharp tightening in financial conditions, thus constraining the flow of credit to the economy," they warned. "Financial stress could worsen an already unprecedented economic recession, making a recovery even more challenging." Enditem

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