## The Last Mile: Financial Vulnerabilities and Risks — Fabio Natalucci (July 2024)

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**Canonical URL:** [The Last Mile: Financial Vulnerabilities and Risks — Fabio Natalucci (July 2024)](https://www.imf.org/-/media/files/oap/oap-home/2024/fabio-nataluccigfsr-presentation-july-2024.pdf)

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### Market sentiment, asset rallies, and interest-rate outlook
- Markets expect most major banks to cut policy rates this year (presentation headline).
- Greater confidence of soft-landing supporting broad-based rally in risk assets, including traditional global risk assets and alternative asset classes.
- Cross-asset performance and Bitcoin and Gold Prices shown with Index, Jan 2019 = 100.
- Equity gains concentrated among the "Magnificent 7": Microsoft, Apple, NVIDIA, Amazon, Alphabet, Meta, Tesla.
- Sentiment on major emerging markets has improved, helping rekindle portfolio flows (Emerging Markets Portfolio Flows measured in USD, billions) and supporting strong sovereign issuance (Emerging Markets Hard Currency Issuance measured in USD, billions).
- Financial conditions have eased since the last GFSR, particularly in Advanced Economies, accompanied by a recovery in credit growth (Financial Conditions Indices reported as standard deviations over the long-term average).

### Valuations, concentration, and near-term market risks
- Earnings-per-share growth expectations rose significantly amid AI-driven productivity optimism (Earnings Per Share Growth Expectations, Percent).
- Market concentration (weight of market capitalization within broad equity indices) increased for current leaders versus 2000s tech bubble leaders; the presentation contrasts Magnificent 7 with tech bubble leaders (Microsoft, Cisco, Intel, Oracle, IBM, Lucent, Nortel).
- Asset valuations show potential over-optimism: corporate bond spreads are narrower than fundamentals-implied (Corporate Bond Spreads Misalignments: Deviation from fair value per unit of risk; percentile).
- Scenario analysis includes materialization of a -2.5 percent single day broad market return.
- Elevated cross-asset correlations and compressed risk-asset volatility coexist with still-elevated global economic policy uncertainty (Global economic policy uncertainty index versus average implied volatility of equity, FX and high-yield credit).
- Option-implied probabilities and interest-rate uncertainty referenced via options on the December 2024 3-month SOFR futures; option-implied interest rate uncertainty presented in basis points, annualized.

### Inflation uncertainty and monetary policy outlook
- Distribution of analysts’ forecasts for core inflation for 2024 shows elevated uncertainty (Probability density; percent).
- Inflation surprises (Cumulative since 2020; percentage points) indicate upside risks to US inflation persist, with market expectations of inflation trending up in general.
- Option-implied probabilities of December 2024 SOFR outlook shown (Percent), reflecting uncertainty around the monetary policy outlook.

### Global real estate and commercial real estate (CRE) vulnerabilities
- Global real property prices shown as Percent, year-over-year; global property sector continues to reprice.
- China’s property market has yet to bottom out; China price is the average of primary and secondary market prices across 70-city; housing starts in units for United States and in square meters for China and Japan.
- Financing for property developers remains challenging (Financing for Property Developers, RMB, trillions), potentially prolonging the adjustment process.
- CRE valuations have plummeted more in the present monetary policy tightening cycle than in previous episodes (CRE Price Trajectories during Rate Hike Cycles, Index = 100 at beginning of cycle).
- CMBS delinquency rate and banks net charge-offs surged in office and multiple sectors (Percent).
- CRE Price-at-Risk model projects three-years-ahead real cumulative growth risks (Percent, three-years-ahead real cumulative growth).
- CRE lending standards tightened in the euro area and the United States (CRE Lending Standards, Percent of net respondents).
- CRE NPLs are rising while coverage ratios are falling across most banks in the United States subcomponent of CRE across banks in the United States.
- Nonfarm nonresidential loans (includes office) represent the largest CRE subcomponent across banks in the United States; CRE segment exposure to Tier 1 capital reported as Percent.

### Banking sector vulnerabilities and regional banks
- Weak tail of banks remains elevated in the first half of 2024; unrealized losses to Tier 1 capital increased as interest rates climbed (Unrealized Losses to Tier 1 Capital, Percent).
- A significant number of US banks have high CRE concentration, high share of uninsured deposits, and large unrealized losses (Banks with unrealized losses > 25 percent of Tier 1 capital flagged).
- Total assets of vulnerable banks by region presented in USD, trillions; commercial real estate exposure to total loans reported as Percent.
- Banks flagged in a majority of risk indicator dimensions shown as total assets (trillions of US dollars, left scale) and number of banks (right scale).

### Credit cycle, corporate stress, and private credit growth
- Payment-in-Kind share of Business Development Companies’ income and corporate bankruptcy year-on-year rates indicate potential intensification of credit-cycle downturn (Payment-in-Kind Share of BDC Income: Left: Percent; Right: Index w/ 2018=1; Corporate Bankruptcy Year-on-Year Rate: Percent).
- Interest coverage ratios of middle market companies presented (Percent).
- Private credit growth has experienced exponential growth over the last two decades (Private Credit Growth, USD, trillions).
- Leverage by issuer type and growing investment in private credit funds by pension funds and insurance firms documented (Leverage by Issuer Type, Percent; Investment in Private Credit Funds by Pension Funds and Insurance Firms, Billions of US dollars; percent).
- Borrowers in private credit are smaller and more leveraged; exposures of traditional financial institutions to private credit have increased rapidly.

### Emerging market financing and sovereign-bank nexus
- In major EMs, local currency bond yields remain high as term premiums widened following higher bond supply (Decomposition of Changes in 10-year Yields: Since 2019Q4, Percent).
- Net issuance and maturing hard currency debt presented in USD bn; frontier market and LIC hard currency issuance has barely kept pace with maturing bonds (Net Issuance (USD bn); Maturing Hard Currency Debt (USD bn)).
- Bank claims on central government shown as Percent of bank assets; sovereign-bank nexus has strengthened further.
- Share of distressed issuers in EM bond index and counts of EM sovereigns with real interest rates minus real growth presented (Share of Distressed Issuers in EM Bond Index, Percent, 3-week average; EM Sovereigns Real Interest Rates Minus Real Growth, Number of sovereigns).

### Government debt, treasury supply, and market functioning
- Net US and EU treasury duration supply relative to GDP presented (Percent).
- Projected US 10-Year Real Term Premiums based on forecasted Treasury securities outstanding (Percent) suggest upward pressure on real term premiums as share of Treasury securities outstanding (net of Fed holding) continues to rise.
- Sensitivity of treasury yields to auction demand has increased (Sensitivity of Treasury Yields to Auction Demand, Basis points).

### Cyber risks and operational vulnerabilities
- The number of global cyber incidents and cyberattacks has risen sharply; the financial sector accounts for about one-fifth of incidents (Global Number of Cyber Incidents; Cyber Incidents and losses in the Financial Sector, 2004-2023: Number, left scale; billion US dollars, right scale).
- Estimated distribution of maximum annual firm loss due to cyber incidents shown (Density; millions of dollars), indicating growing risk of extreme losses.

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_Source: https://www.imf.org/-/media/files/oap/oap-home/2024/fabio-nataluccigfsr-presentation-july-2024.pdf_