The International Monetary Fund has warned that the global economy may be approaching the limits of its ability to absorb further shocks, as depleted energy reserves, stretched government finances and rising bond yields expose vulnerabilities across financial markets. At the same time, the dollar has strengthened on the back of resilient US growth, while European banking supervisors are increasing scrutiny of lenders’ exposure to government debt.
The three developments point to a common challenge for policymakers and investors: financial markets have so far absorbed a series of geopolitical and economic shocks, but their capacity to withstand further disruption may be narrowing.
IMF warns governments have less room to respond
In its latest World Economic Outlook, the IMF said global growth had proved more resilient than expected during the first six months of the conflict in the Middle East. The rerouting of oil supplies away from the Strait of Hormuz and the release of strategic reserves helped limit the initial impact of the US-Iran war on energy prices.
However, emergency oil stocks have fallen, while high public debt and persistent budget deficits are leaving many governments with less room to shield consumers and businesses from another surge in energy costs.
The fund marginally raised its forecast for global economic growth in 2026 to 3.1%, from 3% in its previous update, while leaving its 2027 projection unchanged at 3.4%. But it warned that the balance of risks remained tilted to the downside, particularly if the conflict in the Middle East escalates or becomes prolonged.
Further disruptions to energy infrastructure, cyberattacks and extreme weather could amplify the effects, pushing up energy and food prices and weighing on economic activity.
Global inflation is forecast to reach 4.7% this year before easing to 4.1% in 2027. The IMF urged central banks to avoid overreacting to temporary price increases while remaining prepared to act if inflation becomes entrenched.
The fund also warned that higher energy prices and long-term interest rates could weaken consumption and investment in the coming year. Its UK growth forecast for 2026 was revised up to 1.3%, but the projection for 2027 was lowered to 1.2%.
Dollar gains as investors favour US assets
Despite the risks facing the global economy, the US dollar has strengthened in 2026, reversing expectations among many investors and financial institutions that it would continue to weaken.
The DXY index, which tracks the dollar against a basket of major currencies, has risen by around 4% this year. The rally has been supported by strong demand for American stocks and bonds, robust economic growth and concerns about the financial and political outlook in Europe.
The euro has fallen from around $1.17 to approximately $1.12 as investors reassess risks within the eurozone. French government bond yields have also climbed, widening the gap between French and German borrowing costs amid concerns over France’s public finances.
Higher energy prices have provided another source of support for the dollar. Unlike in earlier periods, when expensive oil tended to weaken the US currency by increasing the cost of imports, the United States is now a net energy exporter. Rising oil and gas prices can therefore support domestic energy revenues, even as they put pressure on consumers and create political difficulties for the administration.
The strength of the American economy has also helped attract foreign capital. Growth exceeded expectations in the first half of 2026, supported by household spending and investment in infrastructure related to artificial intelligence. Investors have continued to buy US corporate debt and equities, reinforcing demand for dollar-denominated assets.
But the rally may be more vulnerable than it appears. The dollar has traditionally benefited both from strong US economic performance and from periods of global turmoil, when investors seek a safe haven. Its recent gains, however, have depended heavily on the appeal of American financial assets.
If the AI investment boom falters or markets suffer a sharp correction, investors could rapidly reduce their exposure to US stocks and bonds, putting pressure on the dollar. That leaves the currency increasingly exposed to shifts in investor sentiment rather than relying solely on its traditional safe-haven role.
European banks face closer scrutiny of sovereign debt
The pressure on government bond markets is also prompting European regulators to take a closer look at the risks held by banks.
Francois-Louis Michaud, chair of the European Banking Authority, said supervisors were carrying out additional checks on lenders’ multitrillion-euro sovereign bond portfolios as yields on some European government debt climbed to multiyear highs.
European banks held more than €4 trillion in sovereign bonds at the end of 2025, equivalent to about 13% of their total assets, according to the regulator’s latest risk dashboard.
Michaud said banks’ exposures appeared manageable so far. Higher income from bond holdings had largely offset the impact of falling bond prices on the economic value of their equity, and the EBA had not seen evidence that recent market movements were causing widespread damage to banks.
Nevertheless, the regulator stressed that existing capital rules should not be interpreted as a reason to disregard sovereign debt risks. Supervisors are discussing with lenders how exposed they are to changes in government bond yields and how effectively they manage or hedge those positions.
Under current European Union rules, banks can hold sovereign debt issued by EU governments without allocating capital against those holdings. Proposed changes to the bloc’s banking framework would introduce charges for concentrated exposures, with the aim of reducing the risk that financial institutions become destabilised by difficulties in the governments whose debt they own.
Michaud declined to elaborate on the policy tools available to supervisors, but his comments underline the growing attention being paid to the relationship between public finances and banking stability.
The EBA is also monitoring the potential consequences of a market correction linked to artificial intelligence. Michaud said the exposure of EU banks to the information and communications technology sector accounted for around 4% of their overall exposure, suggesting that the direct risk remained limited. However, he described AI-related market risks as one of the regulator’s most prominent current areas of discussion.
A narrower margin for error
Taken together, the IMF’s warning, the dollar’s rally and the EBA’s scrutiny of sovereign bond holdings highlight different aspects of the same underlying uncertainty.
Governments face rising financing costs and have fewer resources available to absorb another energy shock. Investors are concentrating on the relative strength of US assets, while European banks must manage substantial holdings of government debt at a time when borrowing costs and concerns about public finances are rising.
None of these developments alone signals an imminent financial crisis. The IMF’s growth projections remain positive, the dollar continues to benefit from demand for American assets, and European banking supervisors say sovereign bond exposures appear contained so far.
The concern is that several sources of resilience could weaken at once. A renewed escalation in the Middle East could drive energy prices higher, worsening inflation and increasing pressure on government budgets. Higher yields could then deepen concerns about sovereign debt, while a correction in AI-related assets could undermine one of the main supports for US markets and the dollar.
For policymakers, the challenge is to rebuild financial and fiscal buffers before another shock arrives. For investors, the central question is whether markets are adequately accounting for the possibility that the resilience seen so far may be harder to sustain.
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