The IMF is watching a recession indicator Wall Street is obsessed with - and it could derail forecasts for a stronger global economy

• The International Monetary Fund has revised up its forecasts for global economic growth.
• The Fund cited "increased global growth momentum and the expected impact of the recently approved US tax policy changes" for its fresh optimism.
• However, the rosier outlook came with a major caveat on financial markets, which the IMF warned could be at the risk of a confidence-shaking correction.

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The International Monetary Fund's upgrade of its global economic growth forecast came with a major caveat: bubbly financial markets are at risk of popping, and that could take a toll on the expansion.

The Fund revised up its predictions for global economic growth in 2018 and 2019 by 0.2 percentage points to 3.9%, citing "increased global growth momentum and the expected impact of the recently approved US tax policy changes."

However, the Fund warned that the recent rallies across financial markets, ranging from stocks to corporate bonds, were looking frothy.

"Rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence." the IMF said.

The Fund was referring in part to the phenomenon of a flat yield curve, where rates on longer-term bonds, which are normally supposed to be substantially higher than their short-term counterparts to reflect the greater risk of lending over longer periods, slip closer to rates on short-term bonds.

Some investors and policymakers worry the trend, especially glaring in the US Treasury market, reflects expectations for weak investment returns over a prolonged period. An inverted yield curve, where long-term rates actually slip below short-term ones, has in the past been a reliable predictor of recessions.

"If global sentiment remains strong and inflation muted, then financial conditions could remain loose into the medium term, leading to a buildup of financial vulnerabilities in advanced and emerging market economies alike," the Fund added.

Risks will mount as long as "yield-seeking investors increase exposure to lower-rated corporate and sovereign borrowers and less creditworthy households."