Surging bond yields wreak havoc on Dalal Street, but IMF sees more pain ahead. Why AI is one of the culprits

Bond yields have skyrocketed to multi-decade highs recently, intensifying the selloff in India’s stock market and wiping out massive sums of investor wealth. Adding to the worries, the International Monetary Fund (IMF) has warned that surging AI-related borrowing costs, among other factors, can lead to further downturns in global markets.

In its October Global Financial Stability Report, the IMF said global markets now face three key risks ahead, each of which has the potential for broader implications. These are artificial intelligence-driven market correction, a sharper rise in sovereign bond yields, and cyberattacks.

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AI market crash ahead?

“An AI market correction could trigger broad deleveraging across asset classes. A bond yield shock could reprice assets and reduce the collateral value of bonds in financial transactions. A cyberattack could disrupt critical operations and weaken confidence. High borrowing, scarce liquidity, and tighter links across markets could amplify the impact into broader financial stress,” the international monetary body said.

While artificial intelligence has become an important support for the global economy and financial markets, faltering AI investment and profitability could challenge optimistic expectations and trigger a correction in asset prices linked to the AI industry, the IMF said, adding that growing leverage could be a catalyst for such a correction.

While soaring bond yields are also already exerting pressure on equity markets due to soaring crude oil prices and fiscal concerns, the IMF highlighted that higher yields can further raise discount rates and depress valuations across other assets, including those that are AI-related, while reducing the value of bonds used as collateral.

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Risk trio with serious negative economic effects

The three risks, which are soaring bond yields, AI-related stress and cyber threats, do not necessarily threaten financial stability but could become systemic impairments to financial intermediation and credit provision, with serious negative economic effects if they are amplified by underlying vulnerabilities, the IMF warned. “Global stress tests suggest that the banking system would remain adequately capitalised in a bond yield spike and AI-led correction scenario, although a significant share of vulnerable institutions would emerge, and some banks’ growing interconnectedness with nonbank financial intermediaries (NBFIs) could prove a source of fragility,” it added.

However, the IMF noted that emerging market and frontier economies have proved relatively resilient during recent shocks as they deployed policy measures, with risk premiums retracing to levels last seen before the war in the Middle East. The widening of emerging market risk premiums at the outbreak of the war was concentrated mainly in currencies, local rates, and equities, but premiums have now retraced to historically compressed levels, it added.

Emerging market authorities have deployed a broad range of measures to cushion the energy shock. Targeted fiscal support has helped contain the pass-through of energy prices to inflation and eased pressure for additional monetary tightening, and monetary policy action alongside targeted currency interventions and capital flow measures have limited near-term financial stress.

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