Dow Jones – The European Central Bank (ECB) warned on Wednesday that it sees the potential for large corrections in global asset prices as investors load up on risky investments and major central banks move toward higher interest rates.
“Signs of increased risk-taking in financial markets are becoming more universal,” the ECB said in its semi-annual financial-stability report. “There are some indications that financial markets may not be fully alert to the possibility that the current favourable market sentiment can change quickly.”
Major central banks have been unwinding their aggressive stimulus programs in recent months to reflect an unusually broad rebound in economic growth. The Federal Reserve has been gently nudging up interest rates for two years, while the ECB announced last month it would halve the pace of its giant bond-buying programme, known as quantitative easing, to €30bn ($35.6bn) a month from €60bn.
The ECB warned that investors aren’t yet pricing in those moves toward higher interest rates. The premiums that investors demand to hold riskier assets have “remained low throughout 2017 even though a number of central banks in advanced economies have begun preparing markets for an eventual recalibration of their policies,” the ECB said.
It warned that valuations may be stretched in some real-estate markets, such as prime commercial properties, and that some eurozone corporate bonds may be overvalued. Issuance of high-yield bonds has remained high in recent years, it noted.
“Corporate bond spreads for some of the lower-rated issuers are looking increasingly tight when compared with fundamentals,” the ECB said.
The ECB also highlighted other potential risks, including a potential re-emergence of concerns around euro area sovereign debt, the weak profitability of the region’s banks, and a spillover from a sudden increase in US bond or stock market premiums.
Valuations of euro area stocks, however, “don’t appear to be exceptionally elevated by historical standards,” it said.