ASSESSING GLOBAL FINANCIAL STABILITY.

• Author: Adrian, Tobias

In the decade since the global financial crisis, there has understandably been great concern about potential threats to global financial stability, and policymakers have wisely remained vigilant in watching for warning signs of possible economic risk. At the International Monetary Fund (IMF), we remain committed to providing our 189 member countries with farsighted analyses of trends in the financial markets, thus guiding them toward sound policy choices that help maintain economic stability.

Risks for the Global Economy

Global economic growth has remained strong, and the IMF's latest analysis suggests that a global recession is not around the corner. However, as we look ahead, the risk of a decline in global growth has increased. Global financial conditions have tightened appreciably in the past few months of 2018, with a significant global sell off in many major financial markets in the last quarter of the year. While there has been a partial retracement of that sell off in 2019--globally, markets are now looking for signs that the financial cycle may finally be turning. That is especially true in the United States, which has been further ahead in the economic and financial cycle compared to most other regions. In addition, investors are focused on the Federal Open Market Committee (FOMC), trying to judge whether the Federal Reserve may be close to ending--or at least pausing--its recent series of interest-rate hikes. Other key concerns include the slowdown in the Chinese economy, continuing trade tensions, and political risks such as Brexit.

In fact, 2018 was the most difficult year for markets since the global financial crisis (Figure 1). Almost every asset class saw negative returns. The few major areas that showed positive results were "safe haven" assets such as U.S. Treasuries, U.K. gilts, and Japanese government bonds. Global financial markets also saw the return of significant volatility in 2018. The VIX index, which is often seen as a proxy for market anxiety, saw several spikes over the course of the year. Markets have recovered somewhat in the new year--with stocks making up about half of their 2018 losses, and with credit spreads tighter by about one-third.

The IMF's Growth-at-Risk Approach

The tightening in financial conditions is important because it can have an impact on downside risks to growth. This relationship is encapsulated in the IMF's Growth-at-Risk approach, which was first introduced in the October 2017 edition of our Global Financial Stability Report (IMF 2017).

Using statistical techniques, we project a distribution of possible outcomes--which, in turn, helps us identify the most adverse scenarios located in the "left tail" of the distribution (with a 5 percent likelihood of occurring). Over time, we can track the changes in these 5 percent tail scenarios, and we can analyze how they respond to changing economic and financial conditions.

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