IMF warns of stock market panic risk as geopolitical tensions rise

Financial markets are underpricing the risks of escalating geopolitical conflict, a dangerous “disconnect” that could trigger significant sell-offs similar to the stock market panic seen in August, the International Monetary Fund has warned.

In its latest assessment of global financial stability risks, the IMF said the relationship between market volatility and geopolitical risk was at its lowest in more than a decade, with investors becoming complacent about the threat to asset prices from military and diplomatic conflicts around the world.

Tobias Adrian, the IMF’s financial counsellor, said “asset prices may not fully reflect the potential impact of wars and trade disputes”.

He added: “Such a disconnect makes shocks more likely because high geopolitical tension could trigger sudden sell-offs in financial markets and prompt volatility to snap back as it catches up to uncertainty. In that case, some financial institutions may be forced to sell assets or deleverage balance sheets to meet margin calls or satisfy risk limits.”

Global stock, bond and commodity prices have remained largely stable in the face of the widening conflict in the Middle East, which has spread to involve Lebanon and Iran. Investors have taken comfort in assets including gold, whose prices have risen to record highs, and the US dollar, the world’s reserve currency.

The IMF pointed to the panicked sell-off in stocks and the sharp appreciation in the yen in early August as an example of the turmoil caused by a sudden shift in investor sentiment. Japan’s Nikkei index declined by 12 per cent in a day, its largest single-day drop in nearly 40 years, after the Bank of Japan raised interest rates in late July. Traders also dumped US equities after weaker than expected jobs figures.

But investors have turned bullish in recent months after interest rate cuts from central banks in the US and the eurozone, and promises for more monetary easing to come after inflation has fallen in advanced economies and labour markets are cooling off.

The IMF said central banks in economies where inflation remains stubbornly high should “push back against overly optimistic investor expectations for monetary policy easing”.

“Where inflation is very close, or at target, policymakers should show openness to easing faster, if evidence suggests inflation may end up undershooting the target for a while,” Adrian said.

The period of aggressive interest rate rises from 2022-23 has given way to regular episodes of market turbulence, including the UK’s mini-budget bond sell-off in September 2022, the collapse of a series of regional US banks in March 2023 and this summer’s stock market decline.

The IMF said the spread of algorithmic trading and AI meant periods of investor panic were becoming more extreme.

“When shocks arrive and volatility rises, hedge funds may further unwind leveraged positions, and algorithmic traders — which have gained significant market shares in various asset classes — may sell in falling markets to protect themselves against further losses, exacerbating price declines,” the fund said.

“Recent advancements in artificial intelligence and machine learning suggest that algorithms may play a larger role in future episodes of turbulence.”