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Fears of Global Liquidity Crunch Haunt Davos Elites

Rising Fed interest rates means “liquidity could drop dramatically, and that scares everyone”, warns IMF deputy

by Ambrose Evans-Pritchard, The Telegraph:

The International Monetary Fund is increasingly alarmed by signs that market liquidity is drying up and may trigger an even more violent global sell-off if investors rush for the exits at the same time.

Zhu Min, the IMF’s deputy director, said the stock market rout of the last three weeks is just a foretaste of what may happen as the US Federal Reserve continues to raise interest rates this year, pushing up borrowing costs across the planet.

He warned that investors and wealth funds have clustered together in crowded positions. Asset markets have become dangerously correlated, amplifying the effects of any shift in mood.

“The key issue is that liquidity could drop dramatically, and that scares everyone,” he told a panel at the World Economic Forum in Davos.

“If everybody is moving together we don’t have any liquidity at all. We have to be ready to act very fast,” he said.

Zhu Min said the worry is that policy-makers still do not understand the complex interactions in the global financial system, where vast sums of money can move across borders at lightning speed.

What the IMF has observed is that market correlations are near an historic peak, with aligned positions in the US equity markets four times higher than the average since 1932. This is a recipe for trouble when the Fed is tightening.

“When rates go up, market valuations have to adjust,” he said.

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