(Bloomberg) -- Recent gains in financial markets don’t adequately reflect dangers looming from higher sovereign debt and disrupted world trade, the Bank for International Settlements warned.

Investors in both stocks and credit, cheered by prospects of government spending and lower borrowing costs, have driven buoyancy that might paint a brighter picture for the world than warranted, the Basel-based institution said.

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“This very sanguine assessment seems to be disregarding some of the very real challenges in the real economy,” Hyun Song Shin, head of the BIS’s monetary and economic department, told reporters. Markets are “vulnerable to repricing from bad news,” he added.

The remarks capture the unease among Basel officials at what they described in a review of the past quarter released on Monday as a “risk-on tone” from investors. Interest-rate cuts in Europe and the UK, and the expectations of such action from the Federal Reserve supported that rally, along with announcements of fiscal spending in the US and Germany.

The BIS warned that upbeat markets contrast with “mounting unease” about the fiscal outlook in advanced economies, evidenced by a steepening of the yield curve at the very long end in all major jurisdictions, between 10- and 30-year bonds.

Shin echoed earlier warnings by his institution that national borrowing burdens seen around the world are reaching levels that are at the limits of sustainability.

“Historical experience shows that market stress can emerge long before debt levels exceed textbook definitions,” he said.

While the BIS chief economist declined to comment on prospects for US rate cuts, a paper included in the quarterly report described how the Fed could limit the hit to growth from tariffs by adopting a look-through strategy with respect to inflation, albeit at a cost.

Over the first three years after the introduction of higher tariffs, this could ensure that the cumulated loss to output declines from 1.6% to 0.1% of annual gross domestic product, the authors estimate.

“A drawback of the look-through strategy is that higher inflation could have second-round effects,” the authors wrote. “Large increases in inflation raise the risk that the look-through strategy could ultimately cause central banks to fall behind the curve. To then restore price stability, they may need to hike policy rates substantially.”

The paper cited the results of a simulation that showed that if the Fed looks through inflation and pursues easing to cushion growth and then drops that approach after four quarters, the subsequent increase in borrowing costs would be bigger than if officials hadn’t adopted such a strategy.

“A delay in responding to higher inflation would come at a cost to economic activity,” they said.

A separate paper found that the inflation expectations of households remain elevated, exceeding actual rates and professional forecasts. In the US, they do so fourfold, suggesting persistent fears that inflation may come back.

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