## Chapter 1 at a Glance

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---

### Overview
- Global financial stability risks are elevated owing to the ongoing war in the Middle East, potential inflationary pressures, rising risks of further tightening in financial conditions, and several amplification channels that could lead from market turmoil to financial instability.
- Since late February, global equity prices have declined while bond yields have risen sharply, driven by a jump in energy prices and market expectations of higher inflation.
- Emerging market assets have been strongly impacted, especially in commodity-importing and more vulnerable countries.
- Markets have functioned in an orderly manner so far, but risks are asymmetric: the longer the conflict continues, the greater the risk that global financial conditions could tighten further and more abruptly.

### Financial market developments and key statistics
- Rising energy prices have raised the expected average inflation over the next two years by 0.3 to 0.8 percentage points, as implied by inflation swap contracts in several advanced and emerging market economies.
- Measures of implied volatility in equity and bond markets have spiked (Chicago Board Options Exchange Volatility Index [VIX] and Merrill Lynch Option Volatility Estimate [MOVE] index).
- Expected paths of monetary policy rates have moved higher, in some cases flipping from cuts to hikes.
- Financial Conditions Indices show global financial conditions have tightened since October 2025 but remain historically accommodative.
- Market-implied inflation expectations and forward yields for G4 five-year, five-year tenor have moved upward since the onset of the conflict.

### Amplification channels and contagion risks
- High debt levels and greater rollover risks in core sovereign bond markets could accelerate the rise in bond yields, while greater volatility in bond markets could tighten funding markets and revive the sovereign–bank nexus.
- Emerging markets may face currency and capital outflow pressures as carry trades unwind and terms of trade worsen.
- Forced selling by nonbank financial intermediaries (NBFIs) that have expanded through leverage could increase volatility further and add liquidity pressures through margin calls and investor redemptions.
  - Equity market volatility could be amplified by option sellers and leveraged exchange-traded funds (ETFs).
  - Bond market volatility could be impacted by hedge funds.
- Liquidity mismatches in private credit appear limited to semiliquid structures, suggesting contained systemic impact, but signs of more borrower defaults ahead could cascade into broader concerns about corporate credit.
- Investment in artificial intelligence (AI) could slow significantly if the conflict persists, weighing on the enterprise value of some firms along the AI value chain that have increasingly relied on circular financing; current impact on financial stability appears modest.
- More frequent supply shocks in recent years have eroded the equity–bond hedging relationship, raising risks of simultaneous deleveraging in both asset classes.
- The chapter also assesses medium vulnerabilities, including the banking sector given its systemic nature, and challenges faced by frontier markets.

### Bond markets: rollover risk and market structure
- Core bond markets saw higher and more volatile bond yields as higher energy prices raised inflation expectations and uncertainty.
- Advanced economies with higher government debt-to-GDP ratios (net of central bank holdings) have higher long-term forward yields and higher term premiums.
- At the 90th percentile, the 10-year US Treasury yield has moved by 11 basis points on auction days since 2023, compared with just 6 basis points in the 2020–22 period.
- Bid-to-cover ratios during auctions have not materially changed; the average bid-to-cover ratio for the relevant 30-year US Treasury auctions has stayed almost constant at 2.5 in the periods 2015–19, 2020–22, and 2023 to now.
- Governments in G4 economies have reduced the weighted average maturities of debt issuances over the past three years by 0.1 to 2.6 years, depending on the jurisdiction.
- Price-sensitive investors—investment funds, foreign investors, and households—hold at least half the G4 sovereign debt.

### Sovereign–bank nexus and emerging-market bank exposures
- A sharp decline in sovereign bond values could affect bank balance sheets while sovereigns may be less able to assist troubled banks.
- In weaker emerging markets (bottom quartile of CCC or below by ratings, or unrated), bank holdings of local-currency government debt increased from 15 percent of banking system assets before the pandemic to 20 percent in 2025.
- IMF staff assessment: banking systems in nearly half the countries rated BB/B, CCC, or lower, or not rated, are estimated to require recapitalization under a severe loss scenario because their regulatory capital ratios fall below 10 percent in a scenario in which domestic debt restructuring shaves 40 percent off both sovereign bond and loan values.

### Policy recommendations
- Be prepared in case of market dysfunction by ensuring that liquidity and funding facilities are accessible and operationally ready.
- Enhance bilateral and regional currency swap lines to preserve stability in funding and foreign exchange markets amid unforeseen ramifications of geopolitical events.
- Central banks should be ready to act decisively in line with their mandates and be attuned to spillovers from actual inflation to inflation expectations.
  - If monetary policy was already properly calibrated before the current shock, monetary authorities may benefit from waiting for more clarity about its likely impact.
  - Transparent communication, central bank operational independence, and robust accountability are critical for policy credibility and public trust.
- Emerging market authorities should continue to strengthen policy frameworks.
  - Where tightening global financial conditions, carry trade reversals, and higher energy price volatility pose risks of disorderly foreign exchange movements, the IMF Integrated Policy Framework offers guidance on appropriate foreign exchange intervention and capital flow management measures, provided they support credible macroeconomic policies and necessary adjustments.
- Shift fiscal stances toward appropriately tighter settings and place public debt on a stable path in the coming years; discretionary fiscal support to protect vulnerable groups from the energy shock should be explicitly temporary and tightly targeted.
- Complete Basel III implementation and avoid an uncoordinated review of regulations that could increase arbitrage and weaken prudential standards; reviews aimed at reducing undue complexity and ensuring consistency with financial institutions’ systemic importance and risk profiles could be beneficial.
- As NBFIs grow more leveraged and more connected to banks, close data gaps, improve cross-jurisdictional data sharing, and enhance oversight.
  - Expand central clearing for government bond repos and broaden access to central counterparties to address potential strains in short-term funding markets.
- Apply stress tests or scenario analyses to banks and, where possible, to NBFIs to assess the impact of a potential rise in illiquidity and corporate credit distress.
  - As retail and semiliquid structures gain market share within private credit, ensure timely recognition of losses in loan valuations.

---

### Daily changes in 10-year bond yield on bond auction days — key observations
- "Bonds have shorter maturities and buyers are more price sensitive, increasing rollover risks in inflationary scenarios."
- Yield reactions in panel 1 "do not account for the different levels of rates across the periods."
- Panel 2 shows outstanding local-currency sovereign debt and its holder composition, expressed as percentage of GDP; labels report weighted average maturity and shares with remaining maturity above 10 years and below 1 year.
- The investor base "Holders" corresponds to the third quarter of 2025 snapshot across the G4 sovereign issuers.
- Gyration in bond markets could:
  - lower the collateral value in repurchase agreement (repo) transactions, raising repo rates and margins.
  - trigger unwinds of "highly leveraged strategies like the cash-futures basis trade" because "higher bond yields push up repo rates, further raising yields."
- Money market funds have increasingly directed inflows away from repos toward US Treasury bills over the past year, reflecting Treasury bills’ supply surge and attractive yields.

### Risk implications
- Shorter maturities and greater buyer price sensitivity increase rollover risks in inflationary scenarios.
- Tightening funding conditions could amplify bond-market stress via collateral and margin channels, and through leveraged-strategy unwinds.

---

### High valuation and concentration in equity markets
- Global stocks have been bolstered by strong earnings and risk premiums compression since the October 2025 GFSR.
- Recent rotation out of software toward tech stocks focused on AI-related hardware.
- Concentration risk is historically elevated in tech-heavy markets, especially in the United States.
- Notable numeric percentiles and values:
  - USA latest percentile: 97.7
  - GBR latest percentile: 78.8
  - DEU latest percentile: 93.5
  - FRA latest percentile: 55.9
  - JPN latest percentile: 72.7
  - KOR latest percentile: 99.7

### Short-term issuance, repo markets, and funding pressures
- Weighted average maturity of newly issued debt has fallen (period averages are simple means over 2015–20 and 2021–25).
- Declines in system liquidity driven by the Federal Reserve’s quantitative tightening and Treasury’s episodic rebuilding of its cash balances at the Federal Reserve.
- Repo rates came under pressure and cash borrowers relied on the Federal Reserve’s Standing Repo Facility (SRF).
- Domestic repo and cross-currency funding spreads have remained broadly stable in G4 economies thus far, reflecting central banks’ proactive reserve management purchases and shifts toward centrally cleared and sponsored repos.
- Sensitivity of overnight repo rates in the United States to both Treasury and especially investment-grade corporate bond issuance has trended up in recent quarters.

### Growing hedge fund leverage and bond-market vulnerabilities
- Rise in volatility from the war in the Middle East increases risk of margin calls, forced deleveraging, and unwinding of positions by some hedge funds.
- Historical precedent: in Q1 2020, hedge funds sold an estimated $172 billion of Treasuries during an unwinding of leveraged cash-futures basis trades.
- After April 2025 market turbulence, US Treasury swap-spread trades by hedge funds declined by almost $80 billion as they deleveraged.
- Gross notional exposure to interest rate derivatives and sovereign bonds rose to over $18 trillion in 2025 from less than $9 trillion in 2020.
- The cash-futures basis trade has expanded to more than $1 trillion.
- The top 10 global hedge funds now account for more than one-third of the gross notional exposure across all hedge funds, up from 20 percent a decade ago.
- Share of illiquid investments in hedge fund portfolios (proxied by Level 3 assets) has increased by over 50 percent.

---

### Net capital flows — emerging markets
- Net capital flows into emerging markets are "lackluster."
- Net portfolio bond inflows continued, in contrast to weakening net foreign direct investment and portfolio equity flows.
- Nonresident flows into emerging markets are concentrated in a small number of countries.
- The 15 major emerging markets referenced: Brazil, Colombia, Chile, Hungary, India, Indonesia, Malaysia, Mexico, Peru, the Philippines, Poland, Romania, South Africa, Thailand, and Türkiye.
- In a sample of 101 emerging markets, the top 25 recipients accounted for more than 90 percent of overall FDI inflows into emerging markets from 2022 to 2024.
- For portfolio categories in 2024, the GDP share represented by the top 15 countries amounts to:
  - 48 percent for portfolio equity
  - 60 percent for portfolio bond
  - 61 percent for foreign direct investment

### FDI reallocation toward AI and tech sectors
- Cross-border greenfield investment has shifted markedly toward energy- and technology-intensive sectors (gas supply, electronics and electrical manufacturing, machinery and equipment, and information and communication services), accounting for more than 40 percent of the cumulative announced value of greenfield projects since 2015.
- Emerging markets appear to be losing share in the overall value of announced projects, implying the reallocation favors economies with stronger technological sectors.
- Policy emphasis: structural policies to enhance productivity gains and build technological capability, including AI preparedness.

### Portfolio flows and global financial conditions
- Recent bond flows are "average at best," and equity inflows are weak relative to past episodes.
- Recent resident outflows are well above historical averages.
- Classification note: A period is classified as having loose financial conditions when its Financial Conditions Index (FCI) rating is below its 25th percentile threshold (−0.66). The global FCI value in the third quarter of 2025 was −1.04.

---

### Equity option markets, short-dated options, and volatility mechanics
- Trading of equity options has risen to close to 80 percent of the volumes in the underlying cash equity market, having risen 60 percentage points from a decade ago.
- Dynamic volatility strategies account for assets under management of around $600 billion.
- Short-dated options, especially zero-day-to-expiry (0DTE) options:
  - Now account for around 60 percent of S&P 500 options volume, up from approximately 40 percent two years ago.
  - On some days, up to 80 percent of volume can originate from options with zero- to one-day expiration on US indices and ETFs.
- In January 2026, US options exchanges began listing new Monday and Wednesday expiries for options on mega cap technology stocks after approval for Nasdaq by the US Securities and Exchange Commission on January 16, 2026.
- The prevalence of dynamic volatility sellers and short-dated expiries raises the likelihood of rapid flips into short (negative) gamma regimes, where procyclical hedging can amplify downward price pressure.

### Expansion of leveraged ETFs and amplification channels
- Leveraged ETFs have grown quickly across the globe, including newer crypto and single-stock products.
- Leveraged ETFs reportedly contributed to the outsized sell-off in Korean equity markets when the KOSPI index lost 12 percent in a single day (Davis and Bartholomew 2026).
- Amplification channels:
  - Procyclical investor flows transmitted via creation and redemption mechanisms.
  - Derivative exposures with broker-dealer counterparties whose hedging activity reinforces price movements.
  - End-of-day rebalancing to reset target leverage producing predictable directionally aligned adjustments near the close.
- Empirical heuristic: stocks with greater leveraged-ETF exposure tend to exhibit higher intraday volatility.

---

### Leveraged ETFs — assets, exposure, and intraday volatility
- Leveraged ETFs are popular in the United States and in other jurisdictions, particularly in Asia.
- After controlling for market returns and stock betas, leveraged ETF exposures are associated with higher volatility only in periods of market stress.
- Within-day patterns indicate higher leveraged ETF exposure is associated with higher intraday volatility, especially in stressed days defined as returns in the 90th percentile and up.
- Sample period: 2020–25 for all leveraged single-stock ETFs.
- Leveraged single-stock ETFs in the sample are tied to tickers: TSLA, NVDA, COIN, AMD, AMZN, APPL, ARM, GOOGL, PLTR, HOOD, META, MSFT, NFLX, and AVGO.

---

### Artificial intelligence (AI) investment, hyperscalers, and circularity
- Estimated $3.4 trillion in AI-related capital expenditure through 2029 could create balance sheet pressures for hyperscalers.
- Hyperscalers have raised more than $100 billion in bond financing since January 2025, supplemented by leveraged loans and intercorporate arrangements.
- Current average implied useful life of “property, plant, and equipment” is around seven years, while GPUs and advanced chips could face obsolescence within shorter horizons.
- Higher technology investment and expenditure is estimated to have added about 0.3 percentage points to average annualized US GDP growth in the first three quarters of 2025.
- Despite increased debt issuance, average credit quality of hyperscalers is described as strong; financial stability risks are assessed as remaining contained for now.
- Circular financing structures among AI-related firms can raise return correlations and valuations, heightening systemic spillover risk if adverse shocks occur.

### Hyperscalers — stylized scenario analysis (Box 1.4)
- Useful life assumptions: three years versus seven years.
- "High capital intensity" defined as the amount of fixed assets fully matching firm revenue.
- Financing assumption: hyperscalers fulfill additional financing needs by issuing debt.
- Quantitative findings:
  - Assuming a useful life of three years, aggregate EBIT margin would drop by more than 9 percentage points because of higher depreciation expenses.
  - Under a high obsolescence (three-year useful life) and high capital intensity scenario, aggregate EBIT margin is entirely wiped out by the new investment required.
  - Present debt levels: $800 billion.
  - Under the three-year useful life scenario and assuming debt issuance to finance investment, debt levels could rise to more than $1 trillion.
  - A Merton-style model suggests debt-weighted average credit default swap spreads of hyperscalers could rise by around 60 basis points.
  - Current spread range cited: 20 to 160 basis points.
- Implication: underestimation of obsolescence risks combined with greater reliance on debt financing could lead to a meaningful rise in corporate risk premium and wider CDS spreads.

---

### Banking sector resilience, NBFI interconnections, and frontier markets
- Global nonperforming loan ratio remained below 1.4 percent as of the coverage period reported.
- Banks with aggregate assets of $25 trillion—12 percent of estimated global banking assets—have been included in the IMF monitoring list.
- Payout ratios rose in 2025, and many global banks have reaffirmed plans to sustain or expand dividends and share buybacks in 2026.
- Bank exposure to NBFIs has grown steadily to nearly 13 percent of world GDP.
- Nearly half of bank NBFI exposures are cross-border and highly concentrated: five jurisdictions account for 73 percent of bank cross-border funding—up 5 percentage points since 2013.
- Frontier Market Resilience Index (FMRI) indicates resilience improved across many frontier markets between 2022 and mid-2025, supported primarily by stronger external positions and lower inflation, though improvements are uneven and elevated public debt levels persist.
- Twelve-month-ahead repayments for emerging markets overall peak at around $140 billion in the first quarter of 2030.

### Capital regulation and supervisory recommendations
- Complete the implementation of the Basel framework and avoid uncoordinated reviews that could undermine prudential standards.
- Reviews aimed at reducing undue complexity and ensuring consistency with institutions’ systemic importance and risk profiles could be beneficial, but reforms should be coordinated across jurisdictions and consider the phase of the cycle to avoid procyclicality.
- Strengthen systemwide surveillance, stress testing, and disclosure of bank sovereign exposures; consider options such as capital surcharges on sovereign bond holdings above specified thresholds where exposures are large.
- Close NBFI data gaps, improve cross-jurisdictional data-sharing, enhance oversight, and ensure sound margining, haircuts, and collateral valuation practices.

---

### Box 1.1 — Rising Japanese Government Bond yields and global allocation
- JGB yields rise and easing of special demand from insurers may have influenced market dynamics.
- Rising JGB yields imposed sizable unrealized losses on JGB domestic investors’ balance sheets, but financial stability risks appear contained given sizable capital and liquidity buffers at banks and insurance companies (IMF 2024).
- In 2025, nonresidents bought ¥13.3 trillion net of long bonds (maturities of 10 years or longer), accounting for 53 percent of all new purchases in 2025.
- The largest life insurance companies reported a combined unrealized loss of ¥13.2 trillion ($83 billion), compared with about ¥11 trillion at the end of the third quarter of 2025.
- The Bank of Japan remained the largest domestic holder of JGBs, at 51 percent of total JGBs outstanding as of the end of June 2025.
- An unwinding of yen carry trades could prompt Japanese investors to increase allocations to domestic bonds, with repercussions for global bond markets in countries where Japanese investors hold a large market share.

---

*Source: Chapter 1 at a Glance (ch1 - Chapter 1 at a Glance), IMF April 2026.*

### Chapter 1 at a Glance

### Chapter 1 at a Glance

### Overview
- Global financial stability risks are elevated owing to the ongoing war in the Middle East, potential inflationary pressures, rising risks of further tightening in financial conditions, and several amplification channels that could lead from market turmoil to financial instability.
- Since late February, global equity prices have declined while bond yields have risen sharply, driven by a jump in energy prices and market expectations of higher inflation.
- Emerging market assets have been strongly impacted, especially in commodity-importing and more vulnerable countries.
- Markets have functioned in an orderly manner so far, but risks are asymmetric: the longer the conflict continues, the greater the risk that global financial conditions could tighten further and more abruptly.

### Financial market developments and key statistics
- Rising energy prices have raised the expected average inflation over the next two years by 0.3 to 0.8 percentage points, as implied by inflation swap contracts in several advanced and emerging market economies.
- Measures of implied volatility in equity and bond markets have spiked (Chicago Board Options Exchange Volatility Index [VIX] and Merrill Lynch Option Volatility Estimate [MOVE] index).
- Expected paths of monetary policy rates have moved higher, in some cases flipping from cuts to hikes.
- Financial Conditions Indices show global financial conditions have tightened since October 2025 but remain historically accommodative.
- Market-implied inflation expectations and forward yields for G4 five-year, five-year tenor have moved upward since the onset of the conflict.

### Amplification channels and contagion risks
- High debt levels and greater rollover risks in core sovereign bond markets could accelerate the rise in bond yields, while greater volatility in bond markets could tighten funding markets and revive the sovereign–bank nexus.
- Emerging markets may face currency and capital outflow pressures as carry trades unwind and terms of trade worsen.
- Forced selling by nonbank financial intermediaries (NBFIs) that have expanded through leverage could increase volatility further and add liquidity pressures through margin calls and investor redemptions.
  - Equity market volatility could be amplified by option sellers and leveraged exchange-traded funds (ETFs).
  - Bond market volatility could be impacted by hedge funds.
- Liquidity mismatches in private credit appear limited to semiliquid structures, suggesting contained systemic impact, but signs of more borrower defaults ahead could cascade into broader concerns about corporate credit.
- Investment in artificial intelligence (AI) could slow significantly if the conflict persists, weighing on the enterprise value of some firms along the AI value chain that have increasingly relied on circular financing; current impact on financial stability appears modest.
- More frequent supply shocks in recent years have eroded the equity–bond hedging relationship, raising risks of simultaneous deleveraging in both asset classes.
- The chapter also assesses medium vulnerabilities, including the banking sector given its systemic nature, and challenges faced by frontier markets.

### Bond markets: rollover risk and market structure
- Core bond markets saw higher and more volatile bond yields as higher energy prices raised inflation expectations and uncertainty.
- Advanced economies with higher government debt-to-GDP ratios (net of central bank holdings) have higher long-term forward yields and higher term premiums.
- At the 90th percentile, the 10-year US Treasury yield has moved by 11 basis points on auction days since 2023, compared with just 6 basis points in the 2020–22 period.
- Bid-to-cover ratios during auctions have not materially changed; the average bid-to-cover ratio for the relevant 30-year US Treasury auctions has stayed almost constant at 2.5 in the periods 2015–19, 2020–22, and 2023 to now.
- Governments in G4 economies have reduced the weighted average maturities of debt issuances over the past three years by 0.1 to 2.6 years, depending on the jurisdiction.
- Price-sensitive investors—investment funds, foreign investors, and households—hold at least half the G4 sovereign debt.

### Sovereign–bank nexus and emerging-market bank exposures
- A sharp decline in sovereign bond values could affect bank balance sheets while sovereigns may be less able to assist troubled banks.
- In weaker emerging markets (bottom quartile of CCC or below by ratings, or unrated), bank holdings of local-currency government debt increased from 15 percent of banking system assets before the pandemic to 20 percent in 2025.
- IMF staff assessment: banking systems in nearly half the countries rated BB/B, CCC, or lower, or not rated, are estimated to require recapitalization under a severe loss scenario because their regulatory capital ratios fall below 10 percent in a scenario in which domestic debt restructuring shaves 40 percent off both sovereign bond and loan values.

### Policy recommendations
- Be prepared in case of market dysfunction by ensuring that liquidity and funding facilities are accessible and operationally ready.
- Enhance bilateral and regional currency swap lines to preserve stability in funding and foreign exchange markets amid unforeseen ramifications of geopolitical events.
- Central banks should be ready to act decisively in line with their mandates and be attuned to spillovers from actual inflation to inflation expectations.
  - If monetary policy was already properly calibrated before the current shock, monetary authorities may benefit from waiting for more clarity about its likely impact.
  - Transparent communication, central bank operational independence, and robust accountability are critical for policy credibility and public trust.
- Emerging market authorities should continue to strengthen policy frameworks.
  - Where tightening global financial conditions, carry trade reversals, and higher energy price volatility pose risks of disorderly foreign exchange movements, the IMF Integrated Policy Framework offers guidance on appropriate foreign exchange intervention and capital flow management measures, provided they support credible macroeconomic policies and necessary adjustments.
- Shift fiscal stances toward appropriately tighter settings and place public debt on a stable path in the coming years; discretionary fiscal support to protect vulnerable groups from the energy shock should be explicitly temporary and tightly targeted.
- Complete Basel III implementation and avoid an uncoordinated review of regulations that could increase arbitrage and weaken prudential standards; reviews aimed at reducing undue complexity and ensuring consistency with financial institutions’ systemic importance and risk profiles could be beneficial.
- As NBFIs grow more leveraged and more connected to banks, close data gaps, improve cross-jurisdictional data sharing, and enhance oversight.
  - Expand central clearing for government bond repos and broaden access to central counterparties to address potential strains in short-term funding markets.
- Apply stress tests or scenario analyses to banks and, where possible, to NBFIs to assess the impact of a potential rise in illiquidity and corporate credit distress.
  - As retail and semiliquid structures gain market share within private credit, ensure timely recognition of losses in loan valuations.

*Source: Chapter 1 at a Glance (ch1 - Chapter 1 at a Glance), IMF April 2026.*

### 1. Daily Changes in 10-Year Bond Yield on Bond Auction Days

### 1. Daily Changes in 10-Year Bond Yield on Bond Auction Days

### Key empirical observation
- "Bonds have shorter maturities and buyers are more price sensitive, increasing rollover risks in inflationary scenarios."

### Notes on figure panels and data presentation
- Yield reactions in panel 1 "do not account for the different levels of rates across the periods."
- Panel 2 "shows outstanding local-currency sovereign debt and its holder composition, expressed as percentage of GDP."
- Labels above bars in panel 2 "report the weighted average maturity of outstanding debt."
- Labels inside bars in panel 2 "show the shares with remaining maturity above 10 years and below 1 year, respectively."
- The investor base denoted as "Holders" refers to "the latest jointly available snapshot across the G4 sovereign issuers, corresponding to the third quarter of 2025."
- Abbreviations provided in the figure notes: BoE = Bank of England; BoJ = Bank of Japan; CB = central bank; ECB = European Central Bank; EGBs = European government bonds; ex. = excluding; JGBs = Japanese government bonds; Fed = US Federal Reserve; USTs = US Treasuries.

### Analysis of market implications (from chapter text)
- "With debt-to-GDP ratios at all-time high levels in core sovereign bond markets and higher energy prices and inflationary forces applying pressure on bond yields, funding markets—historically a locus of fragility during episodes of financial turmoil—could tighten."
- Gyration in bond markets could:
  - "lower the collateral value in repurchase agreement (repo) transactions, raising repo rates and margins."
  - Trigger unwinds of "highly leveraged strategies like the cash-futures basis trade" because "higher bond yields push up repo rates, further raising yields."
- A structural shift noted: "the move of sovereign debt issuance in G4 economies toward shorter weighted average maturities ... has made the link between bond and funding markets more acute."
- US-specific flow behavior: "money market funds have increasingly directed the inflows they received away from repos and toward US Treasury bills over the past year, reflecting Treasury bills’ supply surge and attractive yields."

### Risk implications highlighted
- Shorter maturities and greater buyer price sensitivity increase rollover risks in inflationary scenarios.
- Tightening funding conditions could amplify bond-market stress via collateral and margin channels, and through leveraged-strategy unwinds.

*International Monetary Fund | April 2026*

### CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks

### CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks

### High valuation and concentration in equity markets
- Global stocks have been bolstered by strong earnings and risk premiums compression since the October 2025 GFSR.
- Recent rotation out of software toward tech stocks focused on AI-related hardware.
- Concentration risk is historically elevated in tech-heavy markets, especially in the United States.
- Figure highlights and measures:
  - S&P 500 software (GICS Level 3 Software) and S&P 500 hardware (GICS Level 2 industry) tracked alongside M7, HALO, Bloomberg AI index, and S&P 500.
  - The Bloomberg AI Index tracks the performance of the top 45 companies in cloud computing, semiconductors, and hardware focused on the next generation of computing.
  - The Magnificent Seven (M7): Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.
  - Panel 3 compares the actual 12-month forward P/E ratio with a model-implied fair-value estimate based on the previous five years of weekly data; model-implied estimation framework described in the Online Annex 1.1 of the October 2019 GFSR.
  - Concentration measured via Z-score of the Herfindahl–Hirschman Index; data labels use ISO country codes.
- Notable numeric percentiles and values shown:
  - USA latest percentile: 97.7
  - GBR latest percentile: 78.8
  - DEU latest percentile: 93.5
  - FRA latest percentile: 55.9
  - JPN latest percentile: 72.7
  - KOR latest percentile: 99.7

### Short-term sovereign and corporate bond issuance, repo markets, and funding pressures
- Weighted average maturity of newly issued debt has fallen (panel 1: Number of years; period averages are simple means over 2015–20 and 2021–25).
- Declines in system liquidity driven by:
  - Federal Reserve’s quantitative tightening.
  - Treasury’s episodic rebuilding of its cash balances at the Federal Reserve, which drained bank reserves.
- Repo market implications:
  - With liquidity declining and money funds moving away from repos, repo rates came under pressure and cash borrowers relied on the Federal Reserve’s Standing Repo Facility (SRF).
  - Domestic repo and cross-currency funding spreads have remained broadly stable in G4 economies thus far.
  - Stability may reflect central banks’ proactive reserve management purchases and shifts toward centrally cleared and sponsored repos.
- Risks and sensitivities:
  - Spreads can still widen if bond markets face higher and more volatile yields, more rollover risks, and heavy issuance.
  - Sensitivity of overnight repo rates in the United States to both Treasury and especially investment-grade corporate bond issuance has trended up in recent quarters, coinciding with heavy corporate bond issuance.
- Figure highlights and measures:
  - Panel 2: Repo Market Spreads, Policy Rates, and the Standing Repo Facility (Percent, left scale; billions of dollars, right scale). Spreads measured relative to the federal funds’ lower target rate.
  - Panel 3: Global Short-Term Funding Spreads (basis points), based on daily data from October 2, 2025, to April 2, 2026.
  - Panel 4: US Repo Spread/Duration Supply Beta — elasticity of the overnight repo-policy rate spread to US dollar duration supply, measured in 10-year equivalents per billion dollars; includes UST-repo beta and IG corporate-repo beta controlling for Treasury supply.
  - Abbreviations: AI; bps = basis points; DFR = deposit facility rate; FFR = federal funds rate; GC = one-day general collateral repo rate; IG = investment grade; IOR/IORB = interest rate on reserve balances; SOFR = Secured Overnight Financing Rate; RRP = Reverse Repurchase Facility Rate; SRF = Standing Repo Facility; SD = standard deviation; UST = US Treasuries.

### Growing hedge fund leverage and vulnerabilities to bond markets
- Rise in volatility from the war in the Middle East increases risk of margin calls, forced deleveraging, and unwinding of positions by some hedge funds — potential amplifiers of market stress.
- Historical precedent:
  - In Q1 2020, hedge funds sold an estimated $172 billion of Treasuries during an unwinding of leveraged cash-futures basis trades, contributing to rapid rise in Treasury yields and prompting the Federal Reserve to restart open-ended Treasury purchases for financial stability purposes.
  - After April 2025 market turbulence, US Treasury swap-spread trades by hedge funds declined by almost $80 billion as they deleveraged.
- Expansion of hedge funds’ footprint in fixed-income:
  - Gross notional exposure to interest rate derivatives and sovereign bonds rose to over $18 trillion in 2025 from less than $9 trillion in 2020.
  - The cash-futures basis trade has expanded to more than $1 trillion.
  - Hedge funds also engage in swap spread and other fixed-income arbitrage trades.
- Concentration and illiquidity risks:
  - The top 10 global hedge funds now account for more than one-third of the gross notional exposure across all hedge funds, up from 20 percent a decade ago.
  - Share of illiquid investments in hedge fund portfolios (proxied by Level 3 assets) has increased by over 50 percent.
  - Less-liquid portfolios increase the risk of rapidly deteriorating liquidity mismatches during periods of stress.
- Figure highlights and measures:
  - Panel 1: Relative Value Trades in the US Treasury Market (Trillions of dollars); calculations based on Ehlers and Todorov (2025).
  - Panel 2: Hedge Fund Fixed-Income Arbitrage Index Returns and Financial Stress (Basis points, y-axis; percent, x-axis); financial stress proxied by highest daily monthly value in the Markit iTraxx Europe 5-Year CDS Subordinated Financials Index.
  - Panel 3: Borrowing by Hedge Fund Strategy (Trillions of dollars); multistrategy, relative value, and macro hedge funds have sharply increased prime brokerage and repo borrowing.
  - Panel 4: Top 10 Hedge Funds’ Share of Gross Notional Exposures (Percentage of total).
  - Data sources include BIS; Bloomberg; CFTC; Office of Financial Research; US SEC; IMF staff calculations.

### K-shaped emerging market capital flows and associated vulnerabilities
- Composition shifts in capital inflows to emerging markets have become more uneven and cyclical, increasing vulnerabilities.
- Net capital flows exhibit a K-shaped trend across major balance of payments subcomponents, skewed toward debt with much weaker net portfolio equity and FDI flows.
- Concentration and financing risks:
  - Nonresident portfolio flows increasingly concentrated in a small set of 15 major emerging market economies, leaving others with more constrained external financing.
  - Net FDI has continued to decline from its postpandemic peak, raising concerns about lack of durable long-term financing.
- Dynamics and drivers:
  - Historically, loose financial conditions accompanied strong net capital inflows to emerging markets, but over the past year net flows to emerging markets have been much weaker compared with past instances of loose global financial conditions, particularly for net equity portfolio flows.
  - Resident outflows are more elevated compared with past periods of accommodative financial conditions.
  - In emerging market Asia (excluding China), current account surpluses over the past two years have been recycled as private resident outflows, given diminished home bias and underperformance of emerging Asian equity markets.
  - In bonds, jurisdictions with positive yield differentials relative to the United States have generally seen net portfolio inflows, suggesting heightened carry sensitivity.
- Figure highlights and measures:
  - Panels cover Net portfolio flows, Net other investments, Net direct investment, Net portfolio equity, Net foreign direct investment, Net portfolio bond, Portfolio equity inflows, Portfolio bond inflows, and Foreign direct investment inflows.

*Source: CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks (IMF, April 2026).*

### 1. Net Capital Flows

### 1. Net Capital Flows

### Emerging market capital flows: subdued, uneven, and concentrated
- Net capital flows into emerging markets have been described as "lackluster."
- Net portfolio bond inflows continued, in contrast to weakening net foreign direct investment and portfolio equity flows.
- Nonresident flows into emerging markets are concentrated in a small number of countries.
- The 15 major emerging markets referenced: Brazil, Colombia, Chile, Hungary, India, Indonesia, Malaysia, Mexico, Peru, the Philippines, Poland, Romania, South Africa, Thailand, and Türkiye.
- In a sample of 101 emerging markets, the top 25 recipients accounted for more than 90 percent of overall FDI inflows into emerging markets from 2022 to 2024, underscoring concentration of capital.
- For portfolio categories in 2024, the GDP share represented by the top 15 countries amounts to:
  - 48 percent for portfolio equity
  - 60 percent for portfolio bond
  - 61 percent for foreign direct investment

### Foreign direct investment (FDI) reallocation toward AI and tech sectors
- Cross-border greenfield investment has shifted markedly toward energy- and technology-intensive sectors.
- These sectors (gas supply, electronics and electrical manufacturing, machinery and equipment, and information and communication services) have accounted for more than 40 percent of the cumulative announced value of greenfield projects since 2015.
- Emerging markets appear to be losing share in the overall value of announced projects, implying the reallocation favors economies with stronger technological sectors.
- Implication: economies with weaker technological ecosystems could be displaced and are vulnerable to rising dependence on less-stable financing over the medium term.
- Policy emphasis suggested: structural policies to enhance productivity gains and build on technological capability, including AI preparedness.

### Portfolio flows and global financial conditions
- Recent bond flows are "average at best," and equity inflows are weak relative to past episodes.
- Recent resident outflows are well above historical averages.
- Poor equity returns are a driver of outflows.
- Higher yields drive bond inflows.
- Classification note: A period is classified as having loose financial conditions when its Financial Conditions Index (FCI) rating is below its 25th percentile threshold (−0.66). The global FCI value in the third quarter of 2025 was −1.04.
- Sample coverage for portfolio analyses: first quarter of 2004 through the third quarter of 2025.

### Equity option markets: suppression of volatility and risk of sharp valuation corrections
- Trading of equity options has risen to close to 80 percent of the volumes in the underlying cash equity market, having risen a staggering 60 percentage points from a decade ago.
- Options trading is effectively volatility trading involving three entities: volatility sellers, volatility buyers, and dealers.
- Dynamic volatility strategies (quantitative investment strategies) have grown rapidly and now account for assets under management of around $600 billion.
- Option-based ETFs are described as static volatility strategies with less procyclical behavior.
- Short-dated options, especially zero-day-to-expiry (0DTE) options:
  - Now account for around 60 percent of S&P 500 options volume, up from approximately 40 percent two years ago.
  - On some days, up to 80 percent of volume can originate from options with zero- to one-day expiration on US indices and ETFs.
- Market microstructure dynamics:
  - Dealers intermediate between buyers and sellers and continuously hedge option-related risks by trading the underlying assets.
  - Dealers aim to remain delta neutral but must adjust delta as prices move; whether hedging damps or amplifies moves depends on dealers’ net gamma exposure.
  - The prevalence of dynamic volatility sellers and short-dated expiries raises the likelihood of rapid flips into short (negative) gamma regimes, where procyclical hedging can amplify downward price pressure.
- Regulatory/market note: In January 2026, US options exchanges began listing new Monday and Wednesday expiries for options on mega cap technology stocks after approval for Nasdaq by the US Securities and Exchange Commission on January 16, 2026; these listings increase the frequency with which single-stock options become 0DTE during the week.
- Consequence: equity markets face increased vulnerability to instability amid historically elevated concentration risk, high valuations, and heightened geopolitical risks.

### Expansion of leveraged ETFs and potential amplification of sell-offs
- Leveraged ETFs have grown quickly across the globe, including newer crypto and single-stock products.
- Although leveraged ETF exposures appear limited relative to overall equity market capitalization, they can have an outsized impact through mechanical, procyclical trading flows when overall trading volumes are thin in stressed market conditions.
- Example cited: leveraged ETFs reportedly contributed to the outsized sell-off in Korean equity markets during the early days of the conflict in the Middle East, when the KOSPI index lost 12 percent in a single day (Davis and Bartholomew 2026).
- Three amplification channels for leveraged ETFs:
  - Investor flows tend to be procyclical (retail investors increase exposure after strong returns and reduce it after losses), transmitting flows into fund size and exposure changes via creation and redemption mechanisms.
  - Leveraged ETFs typically obtain exposure through derivatives from broker-dealer counterparties, who hedge using the underlying asset—dealers’ hedging activity tends to reinforce price movements because leveraged exposure rises when prices increase and falls when prices decline.
  - Leveraged ETFs mechanically rebalance at the end of each trading day to reset target leverage, producing predictable directionally aligned adjustments near the close.
- Empirical heuristic: stocks with greater leveraged-ETF exposure tend to exhibit higher intraday volatility.
- Limiting factor: volatility drag from daily leverage and high transaction costs tends to limit sustained buildups in leveraged ETF positions.

*Source: IMF staff calculations and figures from the referenced chapter, "1. Net Capital Flows."*

### 1. Leveraged ETF Total Assets under Managementt

### 1. Leveraged ETF Total Assets under Managementt

### Leveraged ETF exposures and volatility
- Leveraged ETFs are popular in the United States and in other jurisdictions, particularly in Asia.
- After controlling for market returns and stock betas, leveraged ETF exposures are associated with higher volatility only in periods of market stress.
- Outside periods of stress, leveraged ETFs are not associated with persistently higher volatility and may even support market stability, as predictable rebalancing allows liquidity providers to anticipate flows and manage inventories (Barbon and others 2022).

### Intraday patterns and stress amplification
- Within-day patterns suggest that higher leveraged ETF exposure is associated with higher intraday volatility.
- During market stress, volatility exhibits:
  - a level shift (volatility is higher as expected), and
  - an upward-sloping relationship with ETF exposure (volatility rises with ETF exposure).
- The stressed sample includes days with market returns (absolute value) in the 90th percentile and up.
- Toward large exposure values, the confidence band crosses the zero line in the full sample prediction; this is an artifact of thin sample size in that range and extrapolation of the linear fit.

### Mechanisms and market implications
- A larger presence of leveraged ETFs could amplify sell-offs because the interaction of procyclical demand, intraday hedging, and end-of-day rebalancing increases the likelihood that large market moves translate into extreme returns and higher intraday volatility.
- Predictable rebalancing outside stress episodes can allow liquidity providers to manage inventories and potentially support stability.
- To isolate the independent effect of leveraged ETF activity, stock-level panel regressions control for market returns and individual stocks’ betas (see Online Annex 1.3).

### Sample, definitions, and measurement notes
- Sample period: 2020–25 for all leveraged single-stock ETFs.
- Leveraged single-stock ETFs in the sample are those tied to stocks with tickers: TSLA, NVDA, COIN, AMD, AMZN, APPL, ARM, GOOGL, PLTR, HOOD, META, MSFT, NFLX, and AVGO.
- Panel 2 metric: assets of leveraged equity ETFs as a percentage of the jurisdiction’s equity market capitalization (includes leveraged equity index ETFs, not just single-stock ETFs).
- Gross exposure definition: product of the ETFs’ assets and their leverage, reflecting their footprint on the underlying market capitalization.
- Panel 3 horizontal axis: aggregate leverage-adjusted ETF exposure on the underlying stock, expressed as a share of that stock’s market capitalization; chart is a binscatter of the Parkinson intraday volatility proxy for each bucket of ETF exposure (see Online Annex 1.3).
- Panel 4: estimated additional Parkinson variance per additional percentage point of ETF pressure; predicted variance computed keeping the market return at a fixed value to make results comparable.

### Key statistics and specific figures (as presented)
- Sample period: 2020–25.
- Stress sample definition: days with market returns (absolute value) in the 90th percentile and up.
- Leveraged single-stock ETF tickers in sample: TSLA, NVDA, COIN, AMD, AMZN, APPL, ARM, GOOGL, PLTR, HOOD, META, MSFT, NFLX, AVGO.

*Sources: Bloomberg Finance L.P.; Lipper; and IMF staff calculations.*

### CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks

### CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks

### Artificial Intelligence circularity and hyperscalers
- Estimated $3.4 trillion in AI-related capital expenditure through 2029 could create balance sheet pressures for hyperscalers.
- Hyperscalers have raised more than $100 billion in bond financing since January 2025, supplemented by leveraged loans and intercorporate arrangements.
- Current average implied useful life of “property, plant, and equipment” is around seven years, while GPUs and advanced chips could face obsolescence within shorter horizons.
- Higher technology investment and expenditure is estimated to have added about 0.3 percentage points to average annualized US GDP growth in the first three quarters of 2025.
- Despite increased debt issuance, average credit quality of hyperscalers is described as strong, supported by robust balance sheet positions and significant free cash flows; financial stability risks are assessed as remaining contained for now.
- Circular financing structures among AI-related firms can raise return correlations and valuations, heightening systemic spillover risk if adverse shocks occur.

### Equities and bonds: increasing concurrence of sell-offs
- Historical hedging relationship between equities and bonds has weakened; equities and bonds are now more likely to sell off at the same time during adverse shocks.
- From 2009 to 2020, average equity drawdowns were around −9 percent while Treasuries delivered positive returns.
- Since 2020, average equity losses during bear market episodes have deepened to around −17 percent, with Treasuries frequently selling off at the same time.
- Rising VIX has coincided with rising expected returns—or falling prices—for both equities and bonds in recent years, increasing the likelihood of amplified market sell-offs through forced deleveraging and volatility-targeting strategies.

### Banking sector resilience and emerging vulnerabilities
- Global nonperforming loan ratio remained below 1.4 percent as of the coverage period reported.
- Banks with aggregate assets of $25 trillion—12 percent of estimated global banking assets—have been included in the IMF monitoring list.
- Analysts’ forecasts point to some near-term deterioration in bank earnings and mounting pressure on market and liquidity risk metrics.
- Payout ratios rose in 2025, and many global banks have reaffirmed plans to sustain or expand dividends and share buybacks in 2026.
- Evidence indicates that releases of countercyclical buffers mainly support lending by banks with limited headroom; impact typically fades after about three quarters, while stronger capitalization over the medium term lowers equity costs and supports lending.

### Growing bank–NBFI interconnections and risks
- Bank exposure to NBFIs has grown steadily to nearly 13 percent of world GDP.
- Nearly half of bank NBFI exposures are cross-border and highly concentrated: five jurisdictions account for 73 percent of bank cross-border funding—up 5 percentage points since 2013.
- Much of cross-border lending from Canadian, Japanese, and UK banks is directed to the United States.
- Stress in the NBFI sector can significantly reduce banks’ capital ratios and transmit liquidity pressures via sudden unwinding of funding, simultaneous NBFI credit line usage, margin calls on derivatives and repos, and fire sales.
- Data gaps and concentrated global links mean stress from the US NBFI sector can quickly spread across institutions and borders.

### Capital regulation considerations and medium-term trade-offs
- Some authorities have proposed reviewing and simplifying capital regulations to identify unnecessary complexity and lower compliance costs, potentially supporting credit supply and growth.
- Easing capital rules risks increasing regulatory arbitrage and weakening prudential standards if reforms are poorly coordinated across jurisdictions.
- Empirical evidence suggests regulatory easing boosts lending mainly for banks with limited headroom; poorly capitalized banks tend to deleverage and restrict lending more during crises—supporting the argument for adequate capital requirements.

### Frontier markets, sovereign spreads, and external buffers
- Since the onset of the conflict in the Middle East, sovereign spreads of frontier economies have mostly widened, with larger increases concentrated among lower-rated issuers and countries exposed to current account pressures and adverse terms-of-trade shocks.
- IMF staff’s Frontier Market Resilience Index (FMRI) indicates resilience improved across many frontier markets between 2022 and mid-2025, supported primarily by stronger external positions and lower inflation, though improvements are uneven and elevated public debt levels persist.
- Market pricing increasingly differentiates between frontier sovereigns that restructured international debt since 2020 and those that have not; restructurers on average trade at prices higher than similarly rated peers that have not undertaken restructuring.
- Near-term refinancing pressures for lower-rated sovereigns are contained and expected to gradually rise over the next three to five years.
- Twelve-month-ahead repayments for emerging markets overall peak at around $140 billion in the first quarter of 2030.
- Although foreign exchange reserves across most emerging markets have risen gradually since early 2024, foreign exchange reserve adequacy remains constrained for the most vulnerable emerging markets amid the geopolitical shock.

*Source: CHAPTER 1 GlobAl FInAncIAl MArkets conFront the WAr In the MIddle eAst And AMplIFIcAtIon rIsks (IMF), April 2026.*

### 1. Credit Growth versus Lagged Capital Buffers

### 1. Credit Growth versus Lagged Capital Buffers

### Key empirical findings from the charts and notes
- Chart theme: relationship between Change in credit and Change in capital buffers, lagged.
- Region series shown: North America; Asia; Europe.
- Panel 2 description: "Average Capital (CET1) above Disclosed Target Ratio, by Region (Basis points)".
- Data coverage note: "Panel 2 is based on earning transcripts for 78 publicly traded banks, including 20 global systemically important banks reporting CET1 target ratios (lower bound)."
- Geographic definitions in note: "Europe includes the United Kingdom, and Asia includes Australia. CET1 = Common Equity Tier 1."
- Negative and positive scale markers explicitly shown in the chart: −20, −15, −10, −5, 0, 5, 10, 15, 20, 30, 40, 50, 200, 160, 120, 80, 40.
- The figure caption and surrounding text place the chart within a broader discussion of bank capital buffers in relation to credit growth and regional differences.

### Contextual findings from surrounding chapter text relevant to capital buffers and credit
- "Foreign exchange reserve adequacy has not recovered to prepandemic levels for vulnerable emerging markets." (Figure 1.25 reference)
- Vulnerable economies defined in footnote: "Emerging markets having an average rating of B or lower, or not rated, are considered the most vulnerable here."
- "Many emerging markets did not take full advantage of the benign market environment of accommodative global financial conditions and stronger currencies before the conflict in the Middle East to strengthen external positions, including by rebuilding reserve adequacy."
- Emphasis that capital buffers and reserve positions matter for resilience given heightened amplification risks from the war in the Middle East and market turbulence.

### Policy recommendations (excerpted and preserved verbatim where given)
- "Amid the ongoing war and financial market turbulence, authorities should prepare to deal with possible market dysfunction and limit the risk of destabilizing feedback loops."
- "Ensure that sound financial safety nets are in place, contain inflationary pressures, plan to rebuild fiscal and financial buffers, and bolster the resilience of financial institutions, before vulnerabilities bind and self-reinforcing stress takes hold."
- Support market functioning:
  - "National authorities should be ready to intervene and ensure that central bank liquidity facilities are operationally ready, to be deployed swiftly to support market functioning during stress."
  - "Authorities should also ensure that financial institutions can access these facilities, including through periodic tests of access to central banks’ instruments."
  - "Liquidity can be provided to nonbanks with appropriate guardrails (see Chapter 2 of the April 2023 Global Financial Stability Report)."
  - "Bilateral and regional currency swap lines are crucial for preserving stability in funding and foreign exchange markets."
- Monetary policy guidance:
  - "Monetary policy should preserve price stability and be attuned to spillovers from actual inflation to inflation expectations, especially medium to long term."
  - "If monetary policy was already well calibrated before the current shock, monetary authorities may benefit from waiting for more clarity about its likely impact, but they should stand ready to tighten policies to contain second round effects."
  - "Central banks with less firmly anchored inflation expectations—and that have faced persistently high inflation—may need to respond faster."
  - "Central banks facing negative demand shocks may provide further accommodation while remaining attentive to price and financial stability risks."
  - "Across jurisdictions, clear communication should help avoid excessive market reactions to individual data points, anchor inflation expectations and in turn help stabilize bond and funding markets."
- Emerging market policy responses:
  - "Authorities should continue to strengthen policy frameworks and policy credibility."
  - "Exchange rates should generally be allowed to move flexibly to facilitate macroeconomic adjustment to shocks."
  - "The IMF’s Integrated Policy Framework offers guidance on when temporary foreign exchange intervention and capital flow management measures can be appropriate, provided they support credible macroeconomic policies and necessary adjustments."
  - "Stronger surveillance and data systems are also needed to track nonresident hedge funds and leveraged investors active in emerging market assets and to assess the chances of abrupt capital flights."
  - "For weaker sovereign borrowers, efforts to address risks from high debt and fragile recovery should continue, supported by multilateral cooperation and strong international assistance."
- Fiscal policy and rollover risks:
  - "Fiscal stances must shift toward appropriate tightening to rebuild buffers and place public debt on a clearly sustainable path in the years ahead (see the April 2026 Fiscal Monitor)."
  - "Fiscal support to protect vulnerable groups from the current energy shock should be explicitly temporary and tightly targeted, with clear sunset clauses and identified offsets."
  - "Jurisdictions considering shorter-term issuance should assess rollover risks."
  - "Sovereign debt management strategies must account for central bank liquidity frameworks to avoid inadvertently straining secured funding markets when moving toward shorter maturities."
- Funding market stability:
  - "Periodic strains in short-term funding markets call for strengthening market infrastructure by expanding central clearing for government bond repos, especially where bilateral markets dominate."
  - "Wider clearing also needs to be paired with robust central counterparty risk management, including resilient margining, adequate default management resources, and credible recovery and resolution plans."
- Institutional governance:
  - "Central banks’ operational independence, grounded in law and supported by adequate institutional and financial autonomy, must be complemented by clear mandates and robust accountability to ensure policy credibility and public trust."
  - "Effective financial supervision requires authorities that are operationally independent, adequately resourced, and endowed with sufficient legal powers to act decisively in pursuit of clearly defined financial stability objectives."
- Banking sector resilience:
  - "Maintain the resilience of the banking sector by completing the implementation of the Basel framework and avoiding uncoordinated review of regulations that could undermine the effectiveness of international prudential standards."
  - "A review of financial regulatory and supervisory frameworks aimed at reducing undue complexity and ensuring consistency with financial institutions’ systemic importance and risk profiles could be beneficial to growth."
  - "Regulatory changes should consider the phase of the cycle to avoid procyclicality and guard against excessive risk taking in markets."
- Sovereign–bank nexus:
  - "Strengthening systemwide surveillance and stress testing to explicitly capture sovereign risks."
  - "Financial repression measures on banks to hold excessive sovereign debt should be gradually unwound."
  - "Where bank sovereign exposures are large, supervisors should consider options to weaken this nexus, such as capital surcharges on sovereign bond holdings above specified thresholds."
  - "Promote more granular and comparable disclosure of bank sovereign exposures, including information by currency denomination and accounting classification."
- Nonbank financial intermediaries (NBFIs) and margining:
  - "Close remaining data gaps, improve cross-jurisdictional data-sharing, and enhance oversight."
  - "Enhancing transparency and reporting, as well as collaborating, when appropriate, with foreign authorities to reduce challenges that hinder effective cross-border risk identification and monitoring, is important."
  - "The growth of NBFIs may also require expanding central bank operations to address market dysfunctions linked to NBFI liquidity stress."
  - "Supervisors should ensure sound margining, haircuts, and collateral valuation practices to limit excessive leverage and procyclicality."
  - "Strong counterparty credit risk management, including exposure limits, stress testing, and scrutiny of NBFI liquidity risk management, can help contain leverage and liquidity mismatches."
- Monitoring credit markets:
  - "Stress tests and scenario analyses should be applied to banks and, where possible, to NBFIs to assess the impact of a potential rise in corporate credit distress."
  - "Timely recognition of losses in loan valuations becomes increasingly important to help minimize self-reinforcing redemption pressures during periods of market stress."

### Specific data points and references preserved verbatim
- "Panel 2 is based on earning transcripts for 78 publicly traded banks, including 20 global systemically important banks reporting CET1 target ratios (lower bound)."
- "Emerging markets having an average rating of B or lower, or not rated, are considered the most vulnerable here."
- Reference to related material: "see Chapter 2 of the April 2023 Global Financial Stability Report."
- Acronym preservation: "CET1 = Common Equity Tier 1."

*International Monetary Fund | April 2026*

### Box 1.1. Rising Japanese Government Bond Yields Could Affect Global Asset Allocation

### Box 1.1. Rising Japanese Government Bond Yields Could Affect Global Asset Allocation

### Key findings
- Japan’s changes in monetary policy and the easing of special demand from insurers—who were responding to regulatory requirements that mandated a more dynamic, market-consistent approach to measuring financial soundness—may have influenced market dynamics.
- Rising JGB yields have imposed sizable unrealized losses on the asset side of JGB domestic investors’ balance sheets.
- Despite these losses, financial stability risks appear contained given sizable capital and liquidity buffers at banks and insurance companies (IMF 2024).
- An unwinding of yen carry trades could affect global capital flows as investors reassess relative value across markets, with potentially larger effects in markets where Japanese investors hold a large market share (for example, Australia, several euro area countries, and the United States).
- The JGB market has seen an increase in foreign investor inflows: in 2025, nonresidents bought ¥13.3 trillion net of long bonds (maturities of 10 years or longer), accounting for 53 percent of all new purchases in 2025.

### Investor balance-sheet effects and magnitude of losses
- Yields on the 30- and 40-year JGBs typically preferred by lifers had risen 23 basis points over the previous fourth quarter.
- The largest life insurance companies in Japan—Dai-ichi, Meiji Yasuda, Nippon, and Sumitomo Life—reported a combined unrealized loss of ¥13.2 trillion ($83 billion), compared with about ¥11 trillion at the end of the third quarter of 2025.
- Losses reported above predate the record yield increases in January 2026 and therefore offer guidance on possible magnitudes of effects.

### Domestic investment reallocations and dampening factors
- Sharp adjustments seem unlikely because investment mandates at Japan’s largest institutional investors typically adjust gradually.
  - Nippon Life plans a ¥3 trillion shift by selling lower-yielding JGBs in exchange for higher-yielding ones, after a ¥2 trillion rotation during the past fiscal year.
  - Pension funds usually review their investment mandates about once every five years.
- The Bank of Japan remains the largest domestic holder of JGBs, at 51 percent of total JGBs outstanding as of the end of June 2025, dampening procyclical selling pressures.

### Yen behavior, hedging costs, and carry trades
- Despite rising JGB yields, the yen remains historically weak; the typical positive relationship between higher JGB yields and yen appreciation has weakened in recent months.
- Over this period, the yen has depreciated in trade-weighted terms even as JGB yields have risen.
- The US dollar/Japanese yen cross-currency swap basis has narrowed, reducing hedging costs, but yield spreads have shrunk more sharply, making yen carry trades less attractive.
- An unwinding of yen carry trades could prompt Japanese investors to increase allocations to domestic bonds, with repercussions for global bond markets.

### Global spillovers and vulnerable markets
- Increased allocation to domestic bonds in response to changing relative values could spill into global bond markets, increasing debt issuance costs and exacerbating fiscal pressures in other advanced economies.
- The effect would likely be larger for bond markets in countries where Japanese investors hold a large market share, such as Australia, several euro area countries, and the United States.
- Foreign inflows into the JGB market in 2025 were unusually large: nonresidents bought ¥13.3 trillion net of long bonds, the largest amount since comparable statistics began in 2005.

*This box was prepared by Harrison Kraus.*

### Box 1.4. Hyperscalers’ Balance Sheets and Obsolescence Risk: Stylized Scenario Analysis

### Box 1.4. Hyperscalers’ Balance Sheets and Obsolescence Risk: Stylized Scenario Analysis

### Scenario assumptions and methodology
- Useful life assumptions for capital: three years versus seven years.
- Capital intensity scenario: "high capital intensity" defined as the amount of fixed assets fully matching firm revenue.
- Financing assumption: hyperscalers fulfill additional financing needs by issuing debt.
- Credit-risk assessment: a Merton-style model is used to infer potential changes in debt-weighted average credit default swap spreads (see Online Annex 1.9).

### Key quantitative findings
- Assuming a useful life of three years, as opposed to seven years, aggregate earnings before interest and taxes (EBIT) margin would drop by more than 9 percentage points because of higher depreciation expenses.
- Under a scenario of high obsolescence (three-year useful life) and high capital intensity (fixed assets fully matching firm revenue), aggregate EBIT margin is entirely wiped out by the new investment required.
- With lower EBIT, additional debt financing needed increases:
  - Present debt levels: $800 billion.
  - Under the three-year useful life scenario and assuming debt issuance to finance investment, debt levels could rise to more than $1 trillion.
- A Merton-style model suggests debt-weighted average credit default swap spreads of hyperscalers could rise by around 60 basis points.
  - Current spread range cited: 20 to 160 basis points.

### Implications and interpretation
- Higher capital intensity amplifies sensitivity of EBIT margins to useful-life assumptions.
- Underestimation of obsolescence risks combined with greater reliance on debt financing for investment could lead to a meaningful rise in corporate risk premium.
- The combination of depressed profitability (EBIT) and increased leverage raises corporate credit risk as reflected in wider CDS spreads.

*Source: Box 1.4. Hyperscalers’ Balance Sheets and Obsolescence Risk: Stylized Scenario Analysis (CHAPTER 1).*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2026/april/english/ch1.pdf_