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A lengthy conflict in the Middle East would threaten to cause a further surge in interest rates and a sell-off in financial markets that could magnify the wider damage to the global economy, the Bank for International Settlements has warned.
A war that lasts longer or widens more than expected risks putting pressure on asset prices and undermining governments’ fiscal positions, according to a senior official at the BIS, which advises the world’s central banks and manages some of their foreign exchange reserves.
“If the conflict is prolonged, financial amplifications could magnify the macroeconomic impacts,” said Hyun Song Shin, head of the bank’s economics and monetary department, in a press briefing alongside its latest quarterly report.
“A spike in interest rates could put pressure on rich asset price valuations,” he said. “Rising financing costs for governments and the need to issue more debt could undermine fiscal sustainability given already strained public finances in many countries.”
The conflict in the Middle East has already caused a sell-off in equity and bond markets after oil prices surged about 35 per cent following the effective closure of the Strait of Hormuz, the chokepoint through which a fifth of the world’s oil passes.
The BIS said equity markets were already under pressure as investors shifted away from the large US technology stocks over fears of high capital spending and potential earnings disappointment among the “AI hyperscalers”.
The rising oil price has prompted investors to reverse expectations for central banks to cut interest rates and to price in the possibility that some central banks will increase borrowing costs.
Markets have so far “continued to function in an orderly manner, even those most affected by the tensions”, said Shin, but the developments “warrant close monitoring”.
He added: “If the conflict persists or widens beyond current expectations, that could trigger sharper adjustments in inflation expectations and financial conditions” that could “put pressure on rich asset price valuations.”
The BIS said higher borrowing costs and a slowdown in the global economy could add to tensions in private credit markets, where investors have already sought to withdraw billions of dollars from some of the largest managers of US direct lending funds.
Fears about the impact of AI on software as a service providers have led investors to pull their money from listed funds, known as business development companies, the BIS said.
Lending by such funds to software as a service companies has grown rapidly from $8bn in 2015 to more than $500bn, making up 19 per cent of total direct lending at the end of last year, it said. Funds with higher exposure to software companies have underperformed by about 5 per cent, it added.
The rush by investors for the exits has been accentuated by the fear that they could be trapped in these relatively illiquid investments, Shin said.
“I don’t think we can say that the real economy is in a place that would bring about very large credit risk, but given the focus on private credit and the illiquid nature of these vehicles, certainly that has increased the focus on redemptions and the speed,” he said.
