In the April 2025 edition of the Global Financial Stability Report (GFSR), the IMF emphasized several areas of growing concern in the global financial system.
First, the Fund pointed to elevated valuations across both equity and corporate credit markets, reflecting increased investor caution. This caution stemmed from rising geopolitical tensions, a surge in sovereign debt levels, weaker corporate earnings in tariff-affected regions, and uncertainty surrounding the global trade environment. Market sentiment had begun to deteriorate as investors weighed the implications of persistent fiscal imbalances and looming tariff escalations.
Second, the IMF highlighted growing leverage among non-bank financial institutions (NBFIs), notably hedge funds and asset managers. These entities, heavily reliant on prime brokerage services from banks, have been engaging in leveraged strategies that amplify both risk and return. In the event of adverse market movements, these institutions could be forced into rapid deleveraging—triggering asset fire sales and potentially transmitting stress to the broader banking system through counterparty exposures.
Third, the report underscored rising sovereign debt vulnerabilities, particularly in highly indebted advanced and emerging economies. The growing mismatch between fiscal revenues and expenditures is contributing to heightened bond market volatility and increasing rollover risk, especially in jurisdictions with constrained market access or weakening investor confidence.
In its July 2025 World Economic Outlook (WEO) update, the IMF revisited these themes, noting a moderate improvement in near-term financial conditions. The Fund observed that “global financial conditions have eased since the April GFS Report, reverting toward accommodative levels by historical standards.” This shift has been supported by a combination of declining volatility, tightening credit spreads, and continued buoyancy in equity markets.
Equity market valuations have surged further, largely driven by strong earnings momentum in large-cap technology and AI-related firms. Notably, NVIDIA and Microsoft have both surpassed the $4 trillion market capitalization threshold, reflecting investor optimism around innovation and profitability in the sector. However, the IMF flagged potential downside risks, warning that the narrow market breadth and tech-driven rally heighten the risk of a valuation correction, should sentiment reverse.
In the credit markets, tighter spreads reflect a constructive macro backdrop, characterized by resilient growth, improving corporate earnings, reduced expectations of aggressive tariff hikes, and declining default risk. These conditions have been further supported by the flattening of near-term rate volatility and ongoing risk-on positioning among global investors.
On the sovereign side, however, the picture is more nuanced. The IMF noted that “sovereign yield curves for major advanced economies have steepened since April as bond issuance has continued to rise.” This reflects growing concerns about persistent fiscal deficits and the increasing supply of government debt. As investors begin to price in larger financing needs, long-end yields have moved higher—pressuring long-duration sovereign portfolios in developed markets.
That said, emerging market long durations remain attractive, offering compelling real yield differentials amid a still-elevated global rate environment. From a currency perspective, the U.S. dollar remains under pressure, as the earlier retreat from dollar-denominated assets has not yet fully reversed. However, ongoing tariff negotiations and improving global trade sentiment could catalyze a more meaningful recovery in dollar demand.
Written by Michael Ogunremi
References: IMF
